Like people, no business is perfect. As funny as it might sound, many companies inherit the flaws of their founders and managers. The bad news is, flawed characteristics within a company typically do not bode well for selling a business at a high multiple or even selling at all. And while a business certainly can’t eliminate all its flaws, there are a few key tweaks that will help any business prepare itself for the eventual and inevitable transition to new owners.
First, the business must be able to operate devoid of the founder. This could mean very different things for different companies. Some owners hold all the cards in the relationships with key customers, suppliers or employees. For other firms, where the owner is the toiler in the business, he/she is likely the chief cook, bottle washer and probably does the taxes every year as well. In such firms, the business is going to command a very low valuation and will not be as tempting of an acquisition. Insource what makes sense to other internal managers and outsource all the non-core.
Typically, the smaller the company, the more dependent it is on the founding member or manager. That’s at least one of the reasons larger businesses can command higher multiples and are ultimately easier to sell.
Second, build products, not just services. Services businesses are great, but eventually companies should expand services to products that can be sold at scale. Services provide incremental value with marginal costs that make it difficult to readily scale. While I’m a big fan of services businesses, and particularly staffing companies, nothing is more scalable and sellable than a business that provides software
The perfect example of this type of transition is Microsoft. The company originally started in consulting and charging very high costs for creating custom software for other companies. When the opportunity came to acquire an Operating System, tweak it and partner with IBM for distribution, Bill and Paul readily jumped at the idea because they knew that a proprietary product will beat a provided service just about any day of the week.
So, if your company provides services, look for ways to delve into the products side. In today’s environment, that could include hosting and SaaS, PaaS or IaaS solutions. If you’re able to move into such, the ability to sell the business–and do so at a higher overall multiple–greatly increases.
Another excellent way to command a higher multiple and create a turnkey business that could easily sell has to do with existing management. Will they be sticking around after the acquisition? How good are they, really? Are there employee non-compete agreements in place to ensure they are properly incented to stick around for a period of time? Do the current managers own stock that may change the dynamic of a buyout?
Selling a turnkey business requires turnkey management in place. In some cases, investing in such management may require a significant initial drain on cash flow and will certainly take-away from the bottom-line profits of the business. In most cases, such an investment will require a commitment of a year or two to ensure the new managers could handle things in a turnkey fashion.
We know of a couple of business owners who’ve built such companies. The struggle is that once this type of company is operating efficiently, it can be tough to justify selling the business at all, because it becomes a little cash cow for the business owner. Luckily, when timing is right, older owners recognize the assets and the business may be better served in other hands going forward. When that time comes, the transition is much easier when the business operates like a well-oiled machine.