Even if you are not looking to sell your business near term, the mindset, preparation and readiness are essential to the long-term success and value of a business. We have worked with dozens of companies preparing for a sale transaction, and many more trying to build long term value. The similarities between the two strategies are closer than one might think.
Here are a few key factors to consider.
1. First, what are the core elements a buyer will look at? Buyers will look at 3 or more years of financial statements, almost always by month. They will look at budgets and forecasts. They will review the quality of accounts receivable, inventory, equipment, and other assets. They will want to understand how the company generates cash, the stability of where sales and product supply come from and the strengths and weaknesses of the management team. And of course, they will look at where the growth prospects of the company will come from. In summary, what story does all this information say about the quality of the business overall? Can you produce this information? The answer may suggest opportunities within the business.
2. As a business owner, these pieces are essential regardless of any potential sale. What story is the business telling you? As an owner, look at your business through the lens of a buyer. Do your monthly trends make sense? Do they tell the real story? Is the business as profitable as it should be? If not, why? Are your forecasts consistently missing the mark? Does your business lack a handle on its inventory or fixed assets? Forget a sale, these are fundamental components that could be limiting the profitability and value of the business. If you were a buyer, would you buy your business? If the answer is no that suggests deeper issues for the business today. What has to be true for your answer to change to yes?
3. Buyers think long term. Business owners need to as well. No question, short term profits matter. Sales for the next month matter. But a regular examination of the impact of actions and decisions today on the business long term is often overlooked.
4. Many business owners are thinking about selling their business at some point down the road. To be clear, we would certainly not suggest having a full due diligence package ready at any point in time, as the sale process can be extensive with a litany of information being requested and reviewed. But focusing on the core aspects, with good processes and information quality, fulfilling information requests does not have to be a herculean task. And from experience, it can take businesses 2 to 3 times as long and cost 2 to 3 times as much when being reactive and trying to scramble as a potential sale comes into play. A little preparation goes a long way in addition to being a business best practice.
5. Sales happen when you are not planning on them. The market for acquisitions remains strong and is projected to stay that way for years to come. We have seen many instances of unsolicited offers to purchase companies. You never know when that opportunity might present itself, and given a big enough check, just about any business owner would consider a sale. On a more personal note, even if not actively looking for it, have you thought about what that minimum number would have to be to consider a sale?
6. There are many other external uses that could be applicable tomorrow. Whether seeking growth capital from a lender, raising capital from investors, or reaching the scale where reviewed or audited financial statements are sought, the core elements in a presentable format are going to be required in any of these instances.
Look and act the part. Get above the business and look down on it. What needs to change? For the majority of entrepreneurs, their business is their nest egg. Understand its value, examine its value and protect its value. While a sale may not materialize today, the value of a business and anything that can preserve and improve it should be a routine area of focus. Get ready. Stay ready.
Many businesses have made a full recovery in 2021, while others are at least seeing light at the end of the tunnel. The economy is returning to some semblance of normal. Not to be overlooked in the midst of this good news, is the importance of lenders in the continued path forward. What does your lender think of your business right now? How are they viewing you?
Whether simply seeking a renewal, or rather additional financing for growth, an understanding of your lender’s view on your business is critical. Even with longstanding business relationships, the tumult of the past year and a half has impacted lenders, and how they view their clients, in multiple ways.
Here are 5 steps a business can take to successfully manage its lender relationships going forward.
1. Start the conversation early – Do you know how your lender views your business at this point in time? Regardless of how soon a financing event will arise, there is no time to waste in answering these questions. Gain as much insight as possible as soon as possible. Discuss where the business is and where it is headed. Discuss what the business might need going forward. And most importantly what does the bank want to see by way of information on the business?
2. Know how 2020 is evaluated - A key piece of information to understand is how the lender views this past year’s pandemic. Most businesses felt significant economic pain, for at least some period of time. How is the lender taking this setback into account? Some lenders are looking at businesses leading up to the pandemic, and then ignoring parts of Q1 and Q2 for example. Some are studying month over month financials very carefully starting pre-pandemic to present. Others are including some or all of the PPP proceeds in evaluating the historical financial performance. Even if there is no new financing need, does this disruption affect covenants? And for the lucky few that saw record years in 2020, the question of sustainability arises. For example a company that sells cleaning products may have seen a massive uptick that the bank may question whether it is sustainable. Being armed with this information will guide next steps.
3. Prepare good monthly trends – Regardless of how things are being evaluated, they are being evaluated in more granularity. This makes accurate month to month trend information essential to keep track of. Can you produce this information? Ensure that you have the ability to demonstrate a picture that supports company performance. In turn, this should excite a lender to continue and grow a relationship. Take a step back and view your monthly history. Does it support sustained growth? Are there a couple blips along the way that require explanation? The information you provide will tell a story that may require additional context, but if the information is poor, you may lose out before even getting started.
4. Forecast, forecast, forecast – All lenders we are seeing want a forecast into the future. They are not expecting 100% accuracy, but a picture of management’s best idea on where the business is headed is valuable to them. This might be just for the balance of 2021, possibly 12 months from now, or even through 2022. Ask the question and be prepared to show what the future might look like. And just like historical trends, be prepared with the key assumptions and context that a lender might ask about.
5. Limit risk – Banks are not in business to take big risks, so creating a picture for the bank that mitigates risk is the final cog for a business. How does your liquidity look? What about the collateral the business has? How do you show this to the bank? How can you demonstrate an ability to confidently repay any existing debt, but also support additional capital? For many businesses, using the steps above to demonstrate sharp management through and out of the pandemic can be a great source of confidence.
Capital is out there for the right opportunities, but lenders are not obligated to lend you money. Sell potential lenders on the promise of you and your business. Create a holistic business case for what you are seeking. Get out there and grow boldly.
Whether in uncertain economic times or times of growth, entrepreneurs constantly find themselves having to make decisions with less than perfect information. Thankfully, there is a powerful tool and one essential question, that can significantly aid in that process. What if? It is impossible to perfectly forecast or predict the future, but by having an intentional process to evaluate next steps and the myriad of possibilities, it can provide confidence to management teams and the all-important sleep at night factor to the CEO.
The question is established, now what? Here are some key best practices:
• Involve the team – Get input from the management team and key internal stakeholders. If this is an initiative for a new product for example, how does the sales team feel about it? What is operations saying about the ability to execute? Are their potential supply concerns leading to possible delays, or potential issues in production? From a financial perspective, what is the investment required depending on these factors? How much movement could there be in margins based on all these factors. Ultimately, what are the key factors of success? What are the possible impediments that could get in the way? Ask the team for multiple scenarios, perhaps a low, mid and high. Quite literally, ask the team “what if?”.
• Map it Out - Now that this information gathering process is complete, get things down on paper. This creates an ability to see the whole picture in one place and memorialize information. And just like in the first step, involve the management team in assessing this holistic picture. A common mistake is letting prior biases drive decisions too quickly, so having multiple brains to leverage can create new questions and answers in the process.
• The Key Drivers – With this picture, it will become clearer to narrow down the key drivers that will impact the outcome of the decision. Not every factor will ultimately be material in the process. Using our above example of a new product, the time to initial launch could be extremely important (such as the 4th quarter for a retailer), or not important at all for a business with no real seasonality or market pull. A similar approach will help focus in on those factors that really move the needle – capital investment, volume, cost, market demand, etc. Using financial models to move variables around is very helpful in this process. By capturing assumptions and then moving them, the impact of the change can be visualized and evaluated. What would the outcome be if costs are 5% higher than planned? Or if more payroll is required? What if sales are too strong? How does that impact internal supply?
• Build the guardrails – Small businesses are constantly operating with finite resources. A failure to execute as hoped can chew up capital and resources quickly. Growth can also have a similar impact if cash is tied up in production or if customer terms stretch more than expected. What are the bounds within which the business can operate? If the business is a car going down a windy road, the key is keeping the car from going off the cliff. Understanding and firmly establishing the guardrails on either side can serve as a great compass to navigate with.
• Observe and respond – The key here is that if the above process is followed, the business likely has already thought through the scenario that is actually occurring and can respond, instead of just reacting. This creates a proactive process where the business is able to nimbly pivot because it has already contemplated possible outcomes. If sales start out slower than expected, the business should have already contemplated how much additional capital it could use to support the ramp up, or perhaps other areas of marketing spend to explore to add more fuel to the engine.
This what if process can be used as part of the overall annual planning process as well as iteratively throughout the year as new business decisions are being explored. It is one of the most powerful processes we have seen businesses use, especially during the chaos of the pandemic in 2020. Seek input, take a step back, determine what moves the needle, and understand where the guardrails are. Entrepreneurs excel at driving the car, often quickly. This process can make the journey more successful and keep the car running at its best performance. Get behind the wheel and be confident whether that pothole appears, or the speed limit suddenly goes up.
Growth in general is highly sought after in business. Unfortunately, it has also become a term thrown around much too loosely, and without context, growth, in and of itself, can hurt businesses at times much more than it helps. At Fintrepid Solutions, a phrase we repeat often is “growth breaks things”. We have seen it time and time again. We are proponents of intentional growth, where deliberate thought has gone into the goal itself and why it matters, and equally important, what it will take to get there, including potential pitfalls along the way. So the aim then becomes, how do you find the right growth for your business? Here are some considerations to contemplate.
• Defining it – What does growth mean? Is it growing market share? Revenue? Margin? Profit? Something else? These are all very different goals that have different requirements for success. The CEO and leadership team need to have clarity around this. The answer could be to grow revenue by 15% and hold profit margins. It could be to keep revenue flat and grow gross margins. Both could be great answers, but simple growth overall can be unclear and problematic.
• Intentionality – As referenced above, the key is to understand what the goal is and more importantly why it matters. A company can grow revenue by 10% but see profits stay flat. Is that successful growth? The answer is again maybe. Perhaps the company needs to grow to be competitive in the marketplace just to maintain its position or to achieve the same buying power. On the flip side, if there is not an ancillary benefit beyond what shows up in the financial statements, this kind of growth may not be desirable as the business may have added more people, more volume, more complexity, and more headaches to achieve the same net result. What is the desired growth goal and why? Start there.
• Current Assessment – A very stark look at current reality is essential. Where are you now? What led to growth historically? What has hindered growth? Evaluate the good and the bad, the great choices and the mistakes. These answers can provide great context for what is ahead. What can be leveraged further and what is needed once that goal is clearly defined? Too many companies have simply compounded or repeated past mistakes by not evaluating the journey thus far in establishing future growth goals. All dreams have some basis in reality. The same applies in business.
• Resources & Capacity – This is often overlooked in evaluating growth. Growth is stepped. As the diagram below shows, while revenue growth for example might be a line, the capacity, and resources that a business has will fluctuate over time. Growth is a constant toggle between capacity and investment. Often business owners think of capacity in a manufacturing setting, but this could be any combination of people, equipment, or just general infrastructure. Capacity is a key issue to understand in all businesses. Each time an investment in resources is made, the businesses capacity should grow, that spend can then slow while the capacity is absorbed. This process then continues on the next step. In the diagram, there are three companies, A, B and C. Company A may find itself in a situation where its revenue growth is unstable as it is outstripping the resources to support it, possibly leading to systems issues, an overtaxed workforce or quality control concerns. Company C is growing revenue too slowly for the investments made and is investing resources while capacity likely still exists. Company B is in a place of greater stability, utilizing capacity effectively over time and investing in line with growth.
• Cash, cash, cash – Cash is the lifeblood of any business, the gasoline in the fuel tank. Driving too far and too fast can cause the car to stop suddenly. Growth typically uses large amounts of cash, so even if the net profit in a business is increasing, the cash position can be getting even worse. Larger orders from vendors may be needed, terms from new customers may be less favorable, more money can be tied up in people – cash often comes down to timing. We have seen companies grow themselves out of business as a result of cash shortfalls. Understand the impact of the growth goals on cash before getting too far down the road to ensure there is enough fuel to get there.
• The trickle-down effects – What does the desired growth mean financially? What does 20% revenue growth mean for gross margins? Will they be consistent? Is there an opportunity to get better pricing from vendors due to volume and margins could improve? Perhaps an investment in a sales team is needed now to hit the 20% in the following year, meaning profit will potentially decline in the coming year before growing in year 2. Understanding the interplay unique to each business with revenue, gross margins, EBITDA, net profit and free cash flow will ensure alignment in the growth plan.
• The market – A final gutcheck is looking at the broader market. Is the competitive landscape so intense that growth could be hindered, or is it wide open? Is there an opportunity to modify a product to increase margins? Or could larger sales opportunities be more profitable. Could growth land the business on the radar of larger competition? We have seen many instances where growing businesses have faced downward pricing pressure over time as competitors begin to take them on more seriously. Understanding the broader headwinds or tailwinds can and often should alter growth planning as well.
Growth is exciting. It is part of the entrepreneurial DNA. The right growth leads to sustainability and increased value. The wrong growth has caused businesses to severely stumble and even fail. Being thoughtful, intentional, and clear can make all the difference.