I recently worked with a very profitable SME owned by a 67 year old baby boomer. During the course of my work she reflected on the need to sell the business one day. As is the case with many private business owners, she found that the gap between the accounting value of the business and the transactional value in the market can be a deal-killer. The challenge is to get out of traditional accounting thinking and into true business strategy.
The Boomer's business has been running for more than 10 years and has a very interesting model. In the course of my work the owner enquired about the value of the business to which I replied; “You should ask your accountant”.
She asked her accountant, a trusted advisor to any SME, who told her that “if you are buying a business I would say 2 times earnings and if you’re selling I would say 5 times but you will land up at 3 to 3.5 times which is what I think is fair value”. I was with her when she got the email. She did the mental arithmetic and smiled.
The work I was doing was on implementing systems to allow the business to grow. It had become moribund by its use of spreadsheets that, although encompassing essential, proprietary ways of running the business, had begun to stifle its growth. Monthly accounting was done by the owner using a personal accounting package and as a trained accountant she had no problem satisfying the requirements of the business, her accountant and the tax office in this way.
Further, the business is built on some key relationships both in Australia and overseas which the owner had established over the 10 years. She travels frequently to meet these various contacts and enjoys a very close and trusted working relationship with them.
So what’s the business really worth?
The accountant’s valuation is right if the earnings are “sustainable”. The question the buyer will ask in valuing the business is what are the sustained earnings of this business in my hands? With due diligence the buyer will find a multitude of spreadsheets with a confusing methodology and a personal accounting package – no real systems at all to run the business. And on the supply side he will look at the important relationships and ask, will these be of the same value in my hands. The answer is that they may well not.
So the “sustained” earnings are not what is currently generated but a significant discount and the business is as a consequence worth a significant discount to the accountants proclaimed valuation. What I have been working on with the owner is to transform the business into something where the sustained earnings in the hands of a buyer are real and it is worth its true multiple.
We started with systems, building a proprietary relational data base with a formal front end and training manual so that a new employee can quickly become proficient. We installed a full general ledger accounting system with proper reporting and all of the usual safeguards and protections.
We are now in the process of implementing a formal process of aligning the local supplier’s strategy with that of the business to ensure that it is in a position to grow as needed and we have put in place a formal supply agreement. With the overseas supplier we have also formalised arrangements and have started to look for others so that the business is not reliant on the personal relationships of the owner.
This process has been going close to a year now and I expect it will take another few to complete but the good news is that the owner has started the process of taking a really good business in her hands and transforming it into one that will be of equal value to a buyer when the time comes and she wants to sell.