It is important that the value drivers of a company be identified as part of the exit strategy. One major reason is to try to position them so that they will be transferable to an acquirer. Following are some examples:

Product Differentiation

A special taste, a unique formula, a distinctive appearance, and a particular image are characteristics that differentiate products from one another and, as a result, differentiate the company. These characteristics are called value drivers and will usually result in an acquirer paying a higher earnings multiple.

An example is Smartfood cheddar cheese coated popcorn that took the market by storm about fifteen years ago. It seemed that none of the popcorn companies could duplicate the addictive taste of the product.

The Smartfood company sold out to Frito-Lay for four times sales, a premium price for a small regional company. Product differentiation was Smartood’s value driver—their unique and popular popcorn.

Defensible Position

A defensible position is a service or a product that cannot be easily replicated by another company. It may be a government license that allows your company to operate without the likelihood of any additional licenses issued, thus giving your business no or little competition.

To provide an example unrelated to special licenses, your defensible position could be similar to Dispenser Services Inc. (DSI), which operates outside of Boston. DSI sells items such as coffee, orange juice, and yogurt to major institutional cafeterias—including those in hospitals and universities—at prices that are often 30 percent higher than the competition. The hook, however, is that DSI loans rather than leases coffee, juice, and yogurt dispensing machines supported by 24-hour guaranteed service.

DSI has been in business for 20 years with sales and profits increasing annually. The company had more than one million dollars of dispensing equipment on loan with the top institutions in the Boston area. The key value driver is that immediate service and maintenance of the dispensing machines is more important to the institutions than the lowest price for coffee, juice, or yogurt. For a competitor to replace DSI, they would have to start by investing one million dollars in machines that would be loaned out.

Dominant Market Share

An important value driver is for a company to command a position so strong in the market that, by default, it has few or ineffective competitors. One private equity group had a strategy to consolidate subsets of industries, but in niches where there might be only five companies left within that product area, such as lariats, aquariums, and fire hose couplings. This strong market share is the value driver for these companies.

Technology

Proprietary technology does not always have to be patented to be effective. For one thing, it could be a secret process. Take the example of a small Massachusetts adhesive company. The company develops custom adhesives for specialty purposes, usually in small batches. The applications are often critical to the overall situation, which means the adhesive might have to resist high temperatures, withstand extreme pressure, or be completely waterproof. Overall, though, the adhesive is a small cost to the entire project. When the new owner took charge of the company, his first order of business was to double the prices of all the custom adhesives. The owner figured that if he lost 50 percent of his business because of the price increase, he would still be even. As it turned out, he did not lose any customers. Their technology is their value driver.

Protection of engineering talent, intellectual property, and proprietary information are paramount in the successful transfer of ownership in the high-technology industry. Pre- and post-sale agreements with key employees are essential to have in place. The loss of assets previously mentioned would greatly diminish the value of the company. Conversely, the retention of the assets, both people and intellectual property, enhances the company’s value. The validity of the confidentiality agreement and non-compete agreements depends on the ability of the company to enforce them.

Let’s assume that Technology Inc. has obtained confidentiality agreements down to the lowest employee level. In the case of the non-compete agreements, the company granted stock options as part of the contractual agreement. Further, Technology Inc.’s top ten management team members were willing to sign a three-year employees’ contract with Newco to help assure continuity going forward. These agreements, pre- and post-sale of Technology Inc. to Newco, are value drivers for selling the company.

Cost Advantage

Whether it was John Rockefeller’s oil empire or retailer giant Wal-Mart, the advantage of being a low-cost producer is obvious. Even small companies can have a cost advantage, particularly if they are serving a relatively small market.

For example, Walden Paddlers was a virtual kayak company with all its employees leased and all its manufacturing sub-contracted. Walden was only the sixth largest kayak company in the industry, but it was one of the most profitable. It had aligned itself with one of the largest roto-molding manufacturers in the world on an exclusive basis—a manufacturer that was truly a partner. The value driver was the ability of the founder, Paul Farrow, to make Walden a low-cost producer even though it was not the largest company in the industry.

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• Show the real earnings without a lot of adjustments and add-backs. Some examples of possible negative add-backs could be:
  
• Under-funded pension fund commitments
• Under-reserved warranties or guaranties
• No allowance for bad debts
• Under-accrued liabilities for taxes, sales tax, unused vacation and sick leave
• Under insured
• Prepare an exit strategy two to five years in advance by preparing a business plan, preparing accurate and pertinent financial reports, and implementing a culture of continuous improvement.
• Recognize “on and off” balance sheet items such as customer prepayments, work-in-process billing, contract obligations, lease obligations and legal threats.
• Target acquirers that would perceive the company to be the most valuable.
• Understand that valuation is an important exercise, but usually the value determined is not the purchase price. The business will be bought for whatever the seller will take for it.
• Be prepared to accept lower valuation multiples for lack of management depth, reliance on a few customers, and regional versus national distribution.
• Provide a realistic or even a liquidation value for the machinery and equipment. Many acquirers will be using the machinery and equipment as collateral and lenders will usually use a low valuation.
• Be flexible on the real estate as most acquirers would rather lease the real estate component than have it included in the purchase price. Many acquirers would rather invest their money in growing the business.
• Remember the adage: If a business is more valuable to own than to sell, why would anyone buy it?

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There is the old adage that when considering an offer for your business – the highest offer wins. But, truthfully, many times the offer that is most likely to close promptly and with the fewest contingencies is the one that really wins. Here are some thoughts about how to attract those acquirers that may just satisfy both – obtaining the best price and a quick close.

• Know your bottom price and terms. You don’t want to be in the middle of the deal and have to decide this. Know the extent and limit of your negotiations prior to going to market.
• Know how to handle confidentiality. Knowing how to deal with this ahead of time can save a lot of embarrassment. Informing key personnel can allow them to work well with your intermediary.
• Know the acquirer. The acquirer is doing diligence on you – you should be doing it on the acquirer.
• Be careful with add-backs. Including everything and the kitchen sink may make an acquirer suspicious about all of the financial information.
• Clean up the financial statements. Get rid of overdue receivables (collect them or write them off), sell off outdated inventory and equipment, convert owner’s notes to equity, etc.
• See the company through the acquirer’s eyes. If you say something positive about the business, be able to verify it. An acquirer will be looking at everything.
• Anticipate an acquirer’s requests. A serious acquirer will want to see everything there is about the business. Anticipate this and have anything an acquirer would want to inspect ready and available.

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What will you do when you sell?

This all-important question should be addressed prior to even considering an exit strategy. It is one of the biggest reasons perfectly good sales fall apart prior to closing. Sellers need to answer the questions: What will I do if I am not running my company? And, will I be financially set (including the proceeds from the sale) without the income from the business?

Why an exit strategy now?

The time to consider an exit strategy, as many experts often say, is when the business is started or purchased. A business owner should not wait until some event – such as an illness, a personal issue or burnout – forces a sale. Unfortunately, few business owners follow this advice.

Who are your resources?

The time to find good outside advisors to help develop and execute an exit strategy is now – not when you need them. A good accounting firm is a must as is an attorney who is deal experienced. A competent business intermediary is also a must. You don’t need to wait until it is time to sell to consult with one. They can help in explaining the process, in evaluating the strength or weakness of the market place, and even in providing a rough estimate of price.

Is there only one exit strategy?

Business owners sometimes think that selling the business is the only exit strategy. There are multiple strategies: an ESOP, a buyout by management, a public stock offering, a merger, etc. An attorney experienced with exit strategies is a good resource.

How much is your company worth?

This is obviously another all-important question. Many things can influence value, both positively and negatively. Having the business valued once a year is not only good business, but can help determine when it is a good time to exit. That time is generally when business is good and profits are increasing.

A final comment: Most company owners spend the bulk of their time running their business. Keeping a company profitable, competitive and growth-oriented can be a full-time job. However, developing a solid exit strategy is just as important. Being forced to sell without an exit strategy, due to some personal crisis, is just not good business and normally results in a significant amount of money lost.

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