Operating the Business with Equity Value in Mind
By Frank Coker, CMC, MBA - CEO of CoreConnex Inc.
The worst time to sell a company is when you are forced to. But that is exactly what happens to most companies. It could be because of a divorce, a death, a law suit, the loss of a key person, and the list of reasons goes on.
Generally a company that is forced to sell is purchased at a bargain price, which means the owner gets far less than they should or could have if they had more time to prepare.
The only remedy for this is to run a business as if it were going to be up for sale at any time. This is not as hard as it sounds and has many positive side benefits.
“Being on top of your numbers and having current trend reports is key to negotiating business deals from a position of strength.”
Principal, Austin Dale Group
Mergers and Acquisitions
Boosting Perceived Value of Your Business
First, let’s touch on the basics. Companies that show well generally sell well. It’s just like selling a house. If everything is neat and orderly it is going to make a better impression and create a higher expectation of value. A lot of the “show well” elements are simply about have records in order and easy to access and review. Another element of “show well” is found in performance reporting.
If you have a monthly routine of preparing trend data and of tracking progress against goals and benchmarks, you will be way ahead of the curve and ready for anything. This kind of data serves many purposes as we have discussed in other articles in this series, but the added benefit of being ready for any surprise circumstance or opportunity is a major bonus.
The Power of Free Cash
Another basic element of always being ready is having the ability to show how much “free cash” your company is capable of generating. Generally, “free cash” is the money that can be generated each month that is not required to cover operating expenses and capital expenditures. Free cash is the money that the owner can put to work on new investments or can choose to extract from the company for other purposes. Generally, this dollar amount is viewed as the potential return on the investment by the buyer in a M&A (mergers and acquisitions) deal.
Typically the buyer will hire an outside company to determine free cash, and in the process, many conservative assumptions can be made that are often not in the seller’s best interest. The better solution is to preempt this analysis and have your own analysis available. The potential buyer is still going to do their own analysis, but you as the seller will have a much stronger bargaining position if you have your own data ready to show.
One very important aspect of the Corelytics Financial Dashboard is its ability to compute profit in a form that approximates free cash. A basic assumption in the Corelytics profit calculation is that owner incentive compensation as part of profit. This is often a very significant number that is treated as an expense for tax purposes (and a decrease in profit) but from a business performance perspective should be treated as an element of profit and free cash. Even if you aren’t considering an M&A deal, you should always treat owner incentives as part of true profit that gets reported to staff, because that is actually part of the profit generating ability of your company. Any owner compensation above the basic owner’s salary should be treated this way because these dollar amounts are really distributions of free cash which you would not do if the company did not have the financial wherewithal to do so. And of course C-corp small business owners will generally distribute as much available money as possible in the form of incentive compensation in order to minimize double taxation on profits [we will discuss this in more detail in a future article].
There are other actions you can take to maximize your reported free cash and all these can be done through adjustments in the dashboard without making changes to your accounting system data. One of the beauties of a good dashboard is that you can do all the necessary adjustments in the dashboard, to show the true profit generating capabilities of your company (your free cash) without adjusting your basic accounting data. Everything stays in balance, and can be reconciled between the dashboard and the accounting system. All of the heavy analysis is done automatically while you keep a focus on building the value of your business.
7 More Benefits of Being Prepared
Now let’s take a look at some of the additional benefits you can get by having a more meaningful representation of the profit generating capacity of your company. Here are several situations where trend data, market benchmarks and true profit data can give you a stronger and more compelling story to tell:
- Negotiating bank loans and lines of credit
- Communicating with strategic partners that require data on your financial performance
- Development of a stock option plan for employees
- Granting stock options to key staff
- Reporting to the board of directors and board of advisors
- Showing staff how the company is performing
- Being prepared on short notice to take advantage of a deal - like acquiring a company that that just ran into a situation that requires them to sell. If you have a strong financial position, and can show it without delay, you can get tremendous advantage in the deal making process.
In all the above situations, basic financial reports as produced by your accounting systems, only tell a small part of the story. Dashboard graphics and trend data is optimized for showing real performance data and for helping all players to see the real “big picture” of your company.
In summary, having a monthly discipline of analyzing and reporting trends, comparisons to peers (benchmarks), and progress toward goals is not only essential for meaningful communications with staff, but prepares you to take advantage of business opportunities and is important preparation for a worst-case situation that requires you to sell your business. This is one form of insurance and risk mitigation that has a low cost, high value, and which produces benefits every day.