By Cristian Anastasiu and Michael Schwerdtfeger
Over the past few months, we’ve taken a look at ongoing M&A activities in the IT services sector and the reasons for the current consolidation wave. We’ve also talked about how these companies are transforming to reduce risk and drive value to investors. Now, we’d like to walk through three steps you can take to increase the value of your company, if and when you get ready to participate in the wave.
It’s important to remember that these moves can be done fairly easily over the long term but are difficult to implement over the short term. So, understanding areas of improvement before you are ready to undertake a transaction will be helpful in maximizing the value of your company.
1. Make Your Business Scalable: Many companies, in IT services and elsewhere, reach inflection points where the way they did business before is not good enough for future growth. One danger sign is when growing companies don’t invest in people or systems.
Historically, a common growth trajectory for IT services firms started with the founder working out of his garage, growing and adding people over time, and eventually transforming into a company with tens of millions of dollars in revenues. Unfortunately, growth tends to stall out is when the founder can’t transform himself from engineer or customer service professional to the CEO of a significant enterprise. This sort of stall is not surprising — it often takes a different personality and set of skills to be an entrepreneur than to be CEO of a midmarket company. Most commonly, these founders try to use the same systems, infrastructure and organization to run a 50-employee company as they did running a five-employee company.
The solution is investment in people and systems.
First, as long as a company’s founder tries to be the CEO, CFO, sales director and chief bottle washer, she will fail at all of these roles. A growing company will ultimately need a professional financial manager (controller or CFO, depending on the company’s size and sophistication), a sales director and other experts. It is impossible for one person to oversee a growing company and manage every substantive role.
Similarly, at some point, it will become important to invest in systems to allow for future growth and to measure and explain the company’s performance. As an example, many sizable companies try to maintain massive P&Ls on Quickbooks, a tool well-suited to small businesses, but lacking for larger enterprises. In so doing, the company fails to conform to generally accepted accounting practices (“GAAPs”), which ultimately can create a situation where a CEO can’t explain the company’s performance to potential buyers. Just because your financials are “good enough for you” does not mean that they will be good enough for buyers that you will be asking to pay a significant purchase price.
2. Understand the Pros and Cons of Customers: As many lower/middle market companies grow, they fail to analyze the pros and cons of their customers. It is common for businesses to achieve fast growth riding one or two large customers for many years. Often, however, the company doesn’t understand that these customers, while phenomenal for early growth, create a high-risk environment for potential buyers that will make a transaction very difficult.
While it is tough not to continue a great ride with a customer, increasing value demands that you manage your company’s customer concentration.
On the other hand, we have seen transactions where a company fetched a premium when selling to a strategic buyer despite – or maybe because – of that high customer concentration. Consequently, it is crucial to understand potential buyers’ needs and be prepared to address them.
Additionally, many middle-market companies aren’t capable of conducting any analysis of their own service or product mix, resulting in a situation where the company doesn’t truly understand the value it derives from its customers. Instituting metrics to determine profitability is crucial in conveying value to a potential acquirer.
Finally, referring back to last month’s article, shifting your company to build out recurring revenue streams, or at least creating a sticky customer offering, can significantly increase your value.
3. Plan for a Transaction: In addition to creating a valuable organization, making smart personal and corporate planning decisions is crucial to maximizing the value of your business.
As an example, we have many clients that are C corporations and find themselves in the position of having significantly higher tax liability at the time of a sale than they would have if they had initially organized as (or possibly, later converted to) an S corporation, or a limited liability company. A quick consultation with an experienced accountant, well before a possible transaction, may save you hundreds of thousands or even millions of dollars at the time of a sale.
Similarly, putting into place estate and wealth management plans can easily save or generate significant value by decreasing tax exposure and risk.
Most often, it is not enough to talk to your tax preparer about these opportunities. You will want to talk to deal professionals (accountants, lawyers or M&A professionals) who understand your goals and the possible options.
These suggestions are only a small glimpse at the types of things that can make your company more valuable at the time of a transaction. What’s important is that you start early making improvements that can generate significant value for you and your company.
Cristian Anastasiu and Michael Schwerdtfeger are managing directors at Chapman Associates, a national mergers and acquisitions firm providing middle-market companies across various industries with the same resources, expertise and representation that is usually available only to much larger companies. Michael’s e-book “The Inner Workings of a Deal: Tips for a Successful Transaction” is now available for free download. Follow him on Twitter at MBSMergers.