This is the follow-on to my article Top 10 Things That Make Your Business Attractive to Investors. My focus remains on lower middle-market, established businesses.
So, picking up where I left off …
11. Sales Don’t Rely On The CEO/Founder
I addressed some of this in #9 Management Team, but this deserves its own place. There are really great businesses out there that are very profitable, that exhibit tremendous growth and future opportunities, that treat their employees well, etc.etc. However, an achilles heel for many of them is that their CEO/Founder is integral to the customer relationship and sales process. If the CEO/Founder goes (i.e. gets hit by a truck), there goes the business. It’s a well-accepted axiom that people do business with people they know and like. They need to start knowing and liking others in your organization.
To make your business more valuable, start today by removing yourself from the sales process. Set a goal to build out a sales team. Start with just one additional person. Take him/her to your key customers, introduce them, go to lunch, and transition the business to them in a defined period of time. This will obviously require hiring well and increasing your payroll, but that’s always the case as you build out a management team or sales force. This single act will not only mitigate risk for the business and for new investors, but it will also enable you to scale the business much more quickly as you become a more effective business leader, guiding strategy and delegating to others. In addition, if you are at that point in life where you want a true exit after your next capital event rather than a new job, this will go a long ways towards making a shorter transition period.
12. Multiple Revenue Lines
This is another risk-mitigation factor that makes your business more attractive to outside capital. Selling additional products or services, especially when they garner new customers in new industries, will pay huge dividends when it comes time to raise capital or seek an exit. The expanded offering will ideally be a natural follow-on or complement to your core business.
For example, an electrical contractor successfully expanded from a customer base of E&P companies in the oilfield, to providing services to customers in the utility sector. Private equity investors and banks became much more interested in providing capital. A supplier of thread protectors expanded from a customer base of OCTG pipe threaders and pipe distributors into providing disposal services to E&P companies at the rig site, and soon after recapitalized their business with an equity investor. A manufacturer of specialized machine tools expanded from selling the machine tools only, to providing outsourced machining services on behalf of its customers across multiple industries and eventually realized a successful exit/recapitalization with a strategic buyer.
13. Value Proposition Is Easy To Explain
So much of value perception will derive from an outsider’s opinion of you and your management team. When someone (i.e. a potential investor) asks you what your company does, can you give an effective elevator pitch in 30-60 seconds? Most businesses are very simple when you drill down to their essence, but we sometimes make them overly complex in our minds because we’re thinking of all the pieces and parts that factor into our process. It’s not easy running (let alone building) a successful business!
However, investors are savvy – that’s why they’re investors. Usually they’ve seen multiple businesses in multiple industries and will want to distill your business down to its core in short order. They will get there, make no mistake – the question is whether you can get them there quickly, and in so doing, impress them and leave them wanting more. Write it down, practice articulating it to friends and family, get their feedback, and then practice some more. Commit to getting really, really good at your elevator pitch.
14. Low Employee Turnover
Employee turnover is costly – it requires recruiting and training expenses that can quickly expand your HR function, in addition to increasing expenses like printing, travel, and PPE. It is first and foremost relative to your industry. For example, employee turnover at construction companies is extremely high, as laborers come and go and will often jump ship for a seemingly small wage increase. At a manufacturing company, however, it should be much lower.
What you do as a business leader – the culture you create, the managers you put in place, compensation incentives, etc. all contribute to how well you retain your employees relative to others in the industry. It goes without saying then that investors will examine your business in that light.
Many a study has been conducted on why people leave their old company for a new job. Certainly compensation and benefits are significant factors, but from my own learning and experience, equally if not more important are things like:
how they feel about their boss, and in turn, going to work each day
praise and credit, or lack thereof, for a job well done
training to do their work, and to improve their skills
consistency and equity in the way employee policies are enforced
I encourage you to give serious consideration to how well you, your managers, and your supervisors perform on these fronts and take proactive steps to improve. To summarize, decrease your employee turnover and you decrease turnover expense, which increases your value.
15. Clean Safety Record
Safety is inherent to culture, and it starts at the top. One CEO made safety his company’s core value from day one and over the years has ensured it is always a topic on the agenda in most company meetings. You promote and enforce safety first and foremost because you value your employees and their families. It may sound a little trite, but good safety practices save lives and limbs. As that particular CEO likes to say, “everyone just wants to go home and have dinner with their family each night.”
Good safety practices also save you money in the long run. Safety incidents are extremely costly in the ensuing compliance audits/mandates, insurance rate increases, and legal costs from lawsuits. They also lower company morale, which in turn can lead to higher turnover. The natural conclusion of course is that good safety practices (hopefully built into your company’s DNA) will increase your value to those on the outside looking in.
16. Green Halo
We live in a world where “green” matters – period. Like it, love it, hate it, disagree with it … but “going green” responsibly and profitably can enhance value in the years to come. Find something in your business you can do more eco-friendly – hopefully in your mainline service or manufacturing, but even in ancillary things like office waste and recycling. Promote those efforts and celebrate them loudly with potential customers and investors. Be genuine, but unabashed in extolling your accomplishments.
A great example of this was also referenced in #12. A supplier of thread protectors expanded from collecting used thread protectors in the oilfield and reselling them to its existing OCTG customer base, to providing disposal services to E&P companies at the rig site along with a chain-of-custody report. In addition to a second revenue stream, this added a “green halo” to the business and they successfully recapitalized with an equity investor.
17. Clean Books
These last few points are near and dear to my heart as an accounting and finance guy. Clean accounting books are so critical to any process of seeking outside capital from investors. If Investors can’t accurately interpret your results, if they keeping finding material errors and misstatements, they won’t stay interested for very long … unless, 1) they know without a doubt your business is profitable from other evidences like cash in the bank and low debt relative to employee headcount, fixed assets, and sales volume; and 2) it’s relatively easy to get corrected quickly.
So, instead of risking losing their interest because you’re not sure whether you’re following GAAP (Generally Accepted Accounting Principles), invest now in a competent bookkeeper, Accounting Manager, Controller, or CFO, depending on your size. If you’re large enough, you’ll want all of them, in addition to support staff. If you’re small, start with a bookkeeper and consult with an outsourced, part-time CFO who can provide guidance, as well as be there with you when talking to investors. Have them explain to you the various accounting rules that your business requires – all companies have to follow certain rules, but there are specific accounting practices relative to your industry. You may have cut corners on these costs in the past, but now is the time to mature – you’ll need to show that maturity to attract outside capital.
18. Recast Financials
Before you present your Profit & Loss, or Income Statement, to potential investors, you’ll want to make sure the bottom line is reflective of ongoing costs “in the normal course of business” and excludes one-time, extraordinary, and owner-centric expenses. In the negotiation over pricing/value with an investor or acquirer, this will come up and you will likely disagree with the person on the other side of the table on your “addbacks” to profitability. That’s okay. Your job is to present your company’s financial results in the best light possible and reflective of what the business would do under “normal” circumstances, while ensuring the integrity of those results.
A good CFO or Controller can help you help you with the recast. Investment bankers or brokers, who you may hire to assist in a recapitalization event, will also be very experienced in presenting recast financials, but better to come to the table prepared and ready to go to market so they don’t have to do that work. It will save you time, and ultimately money, in the end.
19. Audited Financials
In the best-case scenario, you will actually have your books audited by a CPA firm for the 12-month fiscal period just prior to a financing event. That means, at a minimum, you’ll need your balance sheet audited the year before (to create a “book end”) and then have a full balance sheet and income statement audit for the most recent 12-month fiscal period. Banks will often accept a CPA’s review, and sometimes a compilation, which both have specific procedural definitions that are significantly less than an audit. However, equity investors and acquirers will almost always require an audit. Consult with a CFO on this – you’ll need to find the right CPA firm, at the right price.
20. Quality of Earnings Report
A QOE report is a last step before a major capital event. Similar to an audit, it provides potential investors or acquirers with more assurances and confidence that your stated earnings, or profitability, is real. Essentially, it’s a very detailed examination and rebuilding of your cash flow and income statement.
Investors and potential acquirers most often will want to do this themselves as part of their due diligence. They will hire a firm to come in and perform this examination, which means more headache and cost to you with little to no control over the process. And, they will start from a position of being incentivized to being skeptical of just about everything. To counteract that, more and more companies are proactively having a QOE done themselves and bringing that to the table as part of the submitted due diligence materials. It signals several things, including 1) you’re not hiding anything; 2) you’ve backed up your recast profitability (see #18); and 3) you expect speed and efficiency from the other side in the diligence process.
That wraps up my two-part series on things that make your business more attractive to investors. Find a way to start on these – generally in the order I’ve listed them. Work on your profitability, or EBITDA, as a priority. That solves so many issues up front, it largely dwarves everything else. However, once you’ve got the profitability, all these other things will add up to make a huge difference in the value of your business. Best of luck!