Intangibles, and How They Influence Market Value
Investment bankers deal in the real world of MARKET VALUE, but no value is established until a transaction takes place-a check is written, the contract for services and the earn out is negotiated and agreed to by all parties. We know from experience that all transactions, within a given industry, and for businesses of a certain size, have a range of value. That value is most often measured by a multiple of EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). Therefore, because there is a range of value as measured by a multiple of EBITDA, then there must be more to value than only EBITDA or there would not be a range.
Ignoring for the time being the differences in terms of the deals, and the variance of negotiating skills and competency (or lack thereof) of professionals on both sides of a transaction, the range of value can often be explained by the intangibles of the business. Intangibles are the aspects of the business that do not appear on the balance sheet but provide value to the business and influence the range of value as measured by EBITDA.
Let’s illustrate how important this can be for a business owner. Assuming a business is worth between 3.5 and 4.25 times EBITDA (and in most cases the range is substantially higher than this illustration) and assuming the EBITDA equals $1MM, the range of value amounts to $750,000 or a 21.4% premium. To a small or middle market business owner, this is significant and could amount to the difference between retiring in relative comfort and being able to achieve his or her personal goals, or not achieving them.
How can business owners obtain this 21% premium? We are often asked the most significant ways to improve value in a business. I have listed some of those intangibles below.
Ways for owners and managers to improve the value of a business through INTANGIBLES:
1) Provide for redundancy of management – acquirers do not want to buy a “one man shop.” There is too much risk associated with it and if competent management is in place, you increase the number of prospects to buy the business, thereby increasing the likelihood of obtaining a higher value. Owners should be able to take a three month vacation and come back to a better and stronger business than when they left. Work “ON” your business, not “IN” your business.
2) Cross-train your employees – this reduces risk and increases the number of buyers because you have a stronger business model.
3) Increase the business and financial literacy of all personnel in the company – if employees understand how their actions affect the bottom line (and what the bottom line really means) and how it affects them, they are more responsible in their actions and more productive. Employees are remarkably easier to motivate and manage when they understand the financial drivers of the company and financial transparency has been provided to them. This takes a commitment of resources, but will pay back ten fold in value and benefit to the company.
4) Implement and document systems – it takes the ambiguity out of daily activities. People will know how to handle situations and can “manage by exception” and not by emergency. Utilize customer resource management (CRM) programs, enterprise resource planning (ERP) programs, inventory control systems, sales and management, financial and accounting systems and document them all.
5) Diversify your customer and product base – don’t be overly concentrated in any one customer or product. Again, diversification decreases risk.
6) Have a written business plan in place and measure and compare financial pro forma with actual results. This allows your banker and a prospective buyer to see how the business is organized, how it makes money, how its profitability and cash flow can service debt and how value is created. It will also make it easier to sell the business based upon a higher future value.
7) Keep it simple – the business plan and model. If it is too complicated, the value of the business decreases.
If you address the above 7 points, you will have decreased the risk of your business and increased its value. You will have also lowered your cost of capital, which is a reflection of the perceived risk of your business, which increases value. You will have led to making some tangible improvements in value, such as increased free cash flow and increased asset utilization, which I will address through the “Value Formula” in the next article.
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