The marine industry is facing unprecedented consolidation. Despite this, business owners often wait until an offer is on the table to start planning their exit strategy. Leaving your business and transferring ownership is likely the most significant financial transaction of your life. Nothing you do has greater financial and emotional consequences, and the future quality of your life depends upon how well you manage the process.
However, it is estimated that only 20 percent of business owners have an exit plan. By having no plan, you may be leaving millions of dollars on the table in lost business value. There could not be a more compelling reason to start your exit planning now.
As a business owner, your goal should be to increase the value of your business for a future transaction, whether that is a sale to an outside third party or an internal transfer to key employees or children. You do this by understanding and improving the value drivers of your business as part of your overall ongoing business strategy.
Business Valuation Basics
In simple terms, the value of your business can be expressed as follows: normalized expected cash flows divided by value (cost of capital minus growth rate of cash flows).
Normalized expected cash flows means after taxes and capital expenditures, and before interest and depreciation. Some use EBITDA (earnings before interest, taxes, depreciation and amortization) as a proxy for cash flow. Normalized means that the number is adjusted for items that are not at market rates (such as owners’ compensation) or nonrecurring items (such as lawsuits).
Cost of capital is the expected return that a buyer would demand based on the risk profile of the business. Growth rate is the annual growth in expected cash flows.
Assume a company has a normalized EBITDA of $4 million. After conducting due diligence on the business, the buyer determines a cost of capital of 25 percent. Let’s also assume an expected growth rate of future cash flows to be 5 percent.
Using the formula above, the value of the company will be: $4 million divided by (.25-.05), or $20 million.
This means a buyer who is expecting a 20 percent return on his investment would pay $20 million for the company.
As a business owner, your goal should be to take actions to increase cash flow while reducing the risk associated with achieving those cash flows, thereby increasing the value of your business. With this backdrop, what can you as a business owner do to accomplish this?
These three steps will make sure you get the best offer for your business and reduce the risk of surprises during the due diligence process, thereby paving the way to a successful exit.
First, seek ways to improve the return on invested capital. Working on the following value drivers will help you improve the use of your invested capital to generate increased cash flows: strategic position (take steps to improve your competitive stance in the market relative to your peers); customer base (build a base that appreciates the value your company provides and is willing to pay for it, because a strong customer base equates to quality future cash flows); cost structure and scalability (find ways to allow revenues to grow faster than the cost associated with that growth); and working capital (improve your working capital cycle, or how long it takes a dollar spent to convert to a dollar collected, because the shorter this period, the less capital is needed to fund your operating cycle).
Second, reduce risk. This should result in a lower cost of capital and a rate of return a buyer would seek, thereby increasing the value of your company. Implement changes that address the following key areas of risk: human capital (focus on continuous improvement, incentives and culture, because your ability to grow and thrive is directly related to your ability to attract, retain and reward employees while fostering the sense of ownership and accomplishment); develop your leaders (they should be able to run the company in your absence, reducing the risk of investment); attempt to create predictable revenue streams (ones that are supported by contracts with customers; avoid concentrations (don’t have only one or two customers that make up over 20 percent of your revenues, and make sure you have long-term contracts with strong protective and termination clauses with significant customers and suppliers; identify and correct compliance issues (these can involve taxation, payroll, benefits, labor law and environmental regulations); and always stay current when it comes to critical investments and improvements.
Third, make yours a more transferable business. Eliminate issues that cause deal friction and that increase the risk of a transaction not closing. Typical issues include poorly organized or inaccurate financial information; contracts that can’t be reassigned to a new buyer or owner; lack of clear title for company assets; and wrong corporate structure. (Ensure that your structure will help you achieve maximum after-tax proceeds, and if there are multiple owners, have a formal agreement that provides for drag-along rights of minority shareholders.)
Your private company is an investment, and accordingly, you must continually plan to build, protect and eventually harvest this portion of your wealth. Really, this is what exit planning is all about. It should be part of your overall ongoing business strategy and not something you wait to act on only when an exit is imminent. n
Cherry Bekaert’s Ronald G. Wainwright (email@example.com) is partner, tax, national leader credits/accounting methods. Michael C. Laur (firstname.lastname@example.org) is senior manager, credits/accounting methods. Michael Desiato (email@example.com) is partner. This article was originally published in the July 2021 issue.