Keep widening your moat

When buying a business, one of the qualities buyers look for is barriers to entry. The harder it is for someone to get started in your business or take away your customers, the bigger the barrier.

When investing in businesses, Warren Buffet talks a lot about moats. “In business, I look for an economic castle protected by unbreachable moats,” he says. “If you have an economic castle, people are going to come and want to take that castle away from you. You better have a strong moat.”

The idea of a moat refers to how well your company can keep competitors at bay. Buyers see long-term value in wide moats. The better the moat, the greater confidence the buyer has that your cash flows won’t fall to competition over time.

One way to gauge the width of your moat is to identify your unique selling proposition. The aim is to have “three uniques.”

Maybe you make widgets and you’re one of only a few widget makers who can fabricate them out of carbon fiber. And maybe it’s hard to find short-run manufacturing or someone who will provide widget engineering support for a customer’s research and development work.

The goal is to identify a unique combination of valuable services that sets you apart from everyone else in the market. There may be a limited few who can claim two of your “uniques” but the goal is that no one else can claim all three things you offer your clients.

Identifying your three uniques will show the buyer that you really do have something special – something difficult-to-imitate and proprietary to you.

Then, as you evaluate your business from year to year, ask yourself if your three uniques still stand. Has your competitive advantage gotten stronger (or weaker) than the year before? To buyers, that can be a more important indicator of future value than your revenue and profit alone.

Buyers are looking for long-lasting competitive advantages. So even if your business is having record sales, you need to think about how you are widening your competitive moat.

As Buffet said, “We tell our managers we want the moat widened every year. That doesn’t necessarily mean the profit will be more this year than it was last year because it won’t be sometimes. However, if the moat is widened every year, the business will do very well. When we see a moat that’s tenuous in any way – it’s just too risky.”

When it comes to selling your business, any perceived risk lowers the value. Lower risk, like wider moats, bring more buyers to the table.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

 

7 Keys to Making Your Business Sellable

A business owner recently asked me what she could do to increase the value of her business. She wants to sell and retire in a few years.

My advice was:

  1. It is easier to sell big businesses than small businesses. The magic number is $1 million in adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization). When a business has more than $1 million EBITDA,  it becomes attractive to all buyer types: individuals, strategic buyers, and Private Equity Groups. By the way, $2 million in EBITDA is even better.
  2. to be attractive for sale, a small business needs to make enough money to support a working owner in that geography.  So, if a new owner requires $150K/year in salary, wages, perks, and draws to support themselves and their family, the business needs to be more profitable than that. Below that threshold, a small business just isn’t attractive.
  3. ideally a business can operate and continue to grow without the owner involved every day. That way a new owner can step in without needing any special skills or training. Or a strategic acquirer may be able to integrate the business without hiring a general manager. You still should be running the show. When you are present, the company will run better. But…operationally it should have all the pieces in place to run without you. I advise business owners who want to sell in a few years to start taking more vacations. That forces them to make their business able to operate day-to-day without them.
  4. a key to making a small business attractive to buyers is to have a reliable lead/prospect/customer engine. A good business development engine systematically identifies leads and converts them into prospects and customers. The front end of the engine/funnel could be advertising. It could be prospecting. It could be networking. Ideally, this engine will have the resources to work with and without you, the owner, at the business every day. Steady customer flow is the lifeblood of small businesses.
  5. of prime importance is to determine the products or services at which your business excels, and focus on those products and services. Knowing your focus will help you design your company’s business generation engine. It seems counter-intuitive, but it is easier to sell a specific product in a smaller market segment than a wide array of products into a larger market segment. Of course, the market segment you choose has to be big enough. A great lead/prospect/customer engine will help your business garners more than its fair share.
  6. Growth is important. An attractive business is growing steadily and sustainably. Both top line and bottom line should increase predictably. A consistently growing company will sell at a higher multiple than a company with flat or declining sales.
  7. Paramount is profitability and cash flow. A profitable business is attractive. Cash flow is always king.

Essentially, I advised this owner to pursue business excellence and grow her business to make it attractive to as many types of buyers as possible. If you are considering selling your business one day, this may be good advice for you.

Roy Martinez is a business intermediary with Exit Strategies Group, a leading California-based M&A advisory firm with almost two decades of experience selling small-to-medium-sized and lower middle market businesses. For further information, or to discuss a potential sale or acquisition, confidentially, contact Roy Martinez at 707-781-8583. This post was adapted from Roy’s response to a question from a Sonoma County small business owner.

Biden tax plan driving business owners to market

During his campaign, President Biden proposed tax changes that could have a significant impact on business owners. Any business owner contemplating an exit in the next few years should consider how potential tax changes could reduce their net proceeds from a sale.

If Biden’s tax plans come to fruition, the capital gains tax rate could effectively double, from 20% to 39.6% for income exceeding $1 million. Right now, that means business owners need to shift their focus from maximizing total transaction price to maximizing after-tax proceeds.

Let’s assume your company sells for $10 million in today’s tax environment. Under the current tax rate, you’d net about $8 million after federal taxes. The same company selling for $10 million under Biden’s new tax proposal would net approximately $6 million.

Now let’s say you intend to hold your company and grow it for a few more years. Suppose you grow 5% a year for the next three years for a business value of roughly $12.2 million. Selling under the proposed capital gains taxes you’ll net about $7.3 million. That’s a $700,000 loss in net proceeds, despite three more years of hard work.

These are simplified calculations and other factors will come into play. But under our basic scenario, an owner projecting 5% annual growth would need to run the business for an additional five years to reach a breakeven point after increased capital gains.

Some analysts suggest that new tax legislation won’t pass until year-end 2021 with an effective date of 2022. That could give us a year of breathing room before new taxes go into effect.

As we know, Democrats have control of Congress. And yet, that doesn’t mean tax hikes are a sure thing. With the Senate divided 50-50, and a slim margin in the House, the Democrats don’t have room for dissention in the ranks. Party moderates concerned about economic recovery may push for a more tempered approach.

Business owners contemplating a sale in the next five years should meet with their advisors and consider their exit strategies under different tax outcomes.

Furthermore, business owners without immediate plans to sell should understand the potential impact of increased corporate taxes. Higher ongoing tax bills could have a material impact on an owner’s wealth-building strategies and, consequently, their intentions to sell.

According to the most recent M&A Source and IBBA Market Pulse report, it takes an average of 10 months to sell a lower middle market business. If you’re a business owner and you were thinking about exiting in the next couple of years, start talking to your advisors now.

Begin with an M&A advisor to get a valuation and see if it even makes sense to take your business to market. Then talk to your CPA and run the tax scenarios to understand the best- and worst-case possibilities ahead.

If predictions hold true, M&A deal teams (investment bankers, CPAs, attorneys, and lenders) could have a stressful fourth quarter in 2021 as sellers make a collective push to get deals across the finish line before year end. To my industry colleagues I say, forget those post-COVID travel plans. You’re going to be busy.


Al Statz is the founder and president of Exit Strategies Group, a leading California based lower middle market M&A advisory and business valuation firm. For further information on this topic or to discuss a potential business sale, merger or acquisition, confidentially, Al can be reached at 707-781-8580 or alstatz@exitstrategiesgroup.com.

SBA Covers 3 Months of Payments on New Loans

As part of the Economic Aid Act that passed in December, the Small Business Administration will make borrowers’ payments for three months on new SBA 7(a) and 504 real estate and micro-loan programs.

These incentives were available last summer under a stimulus program that expired in September 2020. Now the program has been revived and enhanced.

The SBA will make the first three months of payments (principal and interest) on new loans approved between Feb. 1 and Sept. 30, 2021. To be clear, these payments will be covered, not deferred or pushed back to the end of the loan period. Payments are capped at $9,000 per borrower per month.

The Section 7(a) loan can be used to buy a business or used for working capital, equipment, or inventory. Qualified borrowers can access up to $5 million.

The SBA’s 504 microloan program can be used for assets that grow your business, including land, facilities, facility improvements, and long-term equipment investments. These loans have similar limits and requirements as the Section 7(a) loans.

Would-be borrowers will have to get approval through an SBA lender. But the good news here is that the new law has increased the federal guarantee for the loans from 75% under last year’s program to 90% this year for most loans. That lowers the risk for lenders and makes it easier for them to extend financing.

Borrowers with existing loans will receive an additional three months of payments and interest, starting February 2021. (These borrowers previously received automatic payment assistance from the SBA.) Plus, borrowers in the hardest-hit industries, such as restaurants, salons, entertainment, arts, and recreation, can receive an additional five months of payments.

The law appears to be written with the intent that the SBA will cover loan origination fees which are 2.5 to 3.5% of the loan amount. That’s something we hoped was coming last summer, but ultimately didn’t come to fruition.

On a loan of $5 million, SBA fees could be about $138,125 or more. That’s free money for buyers who move now and get their loan issued soon. While the program is set to end on September 30, 2021, it could be closed earlier if all funds have been exhausted.

While the law has been approved, the SBA and Treasury Department were still fleshing-out the final rules at the time of writing. The SBA maintains a list of authorized lenders on its website. We recommend reviewing a lender’s SBA loan closure rate to ensure you’re working with an experienced, responsive lender.

If you are acquiring a business, your M&A advisor or investment banker should be able to recommend active SBA lenders with a track record of success.

For advice on financing a business acquisition, contact Al Statz in Exit Strategies Group’s Sonoma County California office at 707-781-8580 or alstatz@exitstrategiesgroup.com.


Exit Strategies Group is a partner of Cornerstone International Alliance.

Six Benefits of Monitoring Company Value

Even if your business is not for sale, monitoring its market value can be incredibly helpful. This article describes six ways that understanding value over the life of a closely held business benefits shareholders, directors and managers.

1. Value Report Card

Like financial statements, an annual independent business valuation is a type of report card on company health. CEO’s can use this report card to educate, align and focus executive teams on maximizing enterprise value. Owners and boards of directors can use it to hold management accountable for value creation.

2. Equity Transaction Enabler

Having a business appraised periodically enables equity transactions. I am talking about buy-sell transactions between shareholders, redeeming stock of retiring owners, and buy-ins by managers, key employees, family, or investors, to name a few.  Most experienced business attorneys will tell you that not agreeing on valuation is the #1 impediment to successfully completing these transactions.  An independent business valuation is usually the fastest route to an agreement on value.

3. Shareholder Agreement Test

A business valuation can be used to test the composition of your shareholder buy-sell agreement from a valuation perspective. In our experience, there are as many faulty buy-sell agreements out there as there are good ones. By faulty I mean that the valuation terms are incorrect or ambiguous, or produce unfair share values, which ultimately leads to surprises, divisiveness, and disputes among shareholders. Also, all buy-sell agreements, regardless of how well-written, lose relevance over time and should be tested periodically. A valuation expert can identify potential problems and recommend solutions.

4. Versatile Planning Tool

A comprehensive valuation report can provide a solid foundation for strategic planning and a roadmap to increasing value. Shareholders can use periodic valuations for their own retirement planning, estate planning, buying life insurance, and maintaining appropriate liquidity for future buyouts. Without an accurate valuation, these planning activities involve a lot more guesswork.

5. Executive Education

The very act of going through a valuation process is educational for owners and leadership teams. They will see what information goes into the valuation and learn what factors are driving or detracting from business value. Experiencing the valuation process also prepares them for what will happen if the buy-sell agreement is triggered or if the company becomes involved in an acquisition.

6. Compliance

You may be aware that ESOP companies are required by law to obtain an annual independent valuation of their shares.  Companies that have stock option plans are required to have regular valuations for IRC 409A and financial reporting purposes. Companies that have executive teams whose compensation is tied to company value through the use of stock appreciation rights or phantom stock plans need valuations as well.

Getting This One Done!

An experienced business appraiser can usually recommend the appropriate scope of analysis and reporting for your intended use and circumstances after a brief phone call with you. In many cases, a full scope business valuation (appraisal) is necessary or strongly recommended. In other cases, a limited scope calculation of value may be sufficient. At issue are accuracy, the knowledge of intended users, credibility, compliance requirements and cost.

Working with the same valuation analyst (appraiser) over time has additional benefits.  Your team gets to know and trust the valuation expert. The expert’s knowledge of the company and its industry grows, and they become better able to offer insights into improving business operations, financial results, enterprise value, sale readiness and marketability. Also, valuation updates are generally faster, less expensive and more consistent.


Al Statz is the founder and president of Exit Strategies Group, a leading lower middle market M&A advisory and business valuation firm. For further information on this topic or to discuss a potential business sale, merger or acquisition, confidentially, Al can be reached at 707-781-8580 or alstatz@exitstrategiesgroup.com.

Plan Your 2021 Comeback with a Strategic Acquisition

Business owners tend to think more seriously about selling when things aren’t as much fun as they used to be. Running a business in the COVID era is anything but fun, and owners are being particularly responsive to acquisition inquiries right now.

Proactive Acquisition Searches

When growing through acquisition, companies can be reactive or proactive. In a reactive strategy, the buyer takes phone calls and watches open market listings for appropriate opportunities to appear. This is a slow process, and buyers often settle for something “close enough” rather than an ideal fit. Proactive buyers work with M&A advisors to build proprietary deal flow. The advisor conducts a disciplined search that targets passive sellers, i.e. owners who would consider selling if the right opportunity came along, but who haven’t listed their businesses on the open market.

Current Supply and Demand

Companies in reactive acquisition mode may be surprised by the level of competition in the acquisition market. COVID has shaken business confidence which is why there are so few quality companies going to market right now. If fact, conditions are similar to the residential housing market. Too few sellers are listing, which means houses are selling fast, above asking prices. In the current M&A market, strong businesses (particularly those relatively unaffected by the pandemic) are finding that lack of supply to be working in their favor.

The Search Process

  • In a proactive acquisition process, the critical first step is to define your strategy. An M&A advisor will  drill into your business model, strengths and weaknesses, culture and revenue streams to help you define your ideal target. What sort of acquisition will create a “one plus one equals three” outcome for your business?
  • From there, your M&A search team generates a list of potential targets. Typically this involves in-depth database searches as well as their own network sources. As a client, you review and approve this list before outreach begins.
  • Next, your M&A team begins a disciplined outreach strategy to generate seller interest. The goal is to bring multiple opportunities to the table at the same time so you have choices and negotiating leverage. You’ll view executive summaries of each opportunity and move into management presentations with a short list of sellers. When the strategy is clear and response has been good, it can take 60 to 90 days to reach this point.
  • Once you’ve identified your prime target, the next step is to negotiate a Letter of Intent (LOI) with the seller. An LOI is a written expression of a buyer and seller’s intent to enter into a transaction. The LOI includes non-binding terms such as purchase price, deal structure, indemnification, management arrangements, timeline, and key closing conditions. Completing an acquisition can be costly and time consuming, so you want to take time to carefully define LOI terms before you spend more time and resources on an acquisition. The LOI phase typically takes 2-4 weeks.
  • At this point in the process, you have not yet done comprehensive due diligence. Due diligence can take another 60 to 90 days before investigations are completed and definitive agreement terms are settled.

All together, a proactive acquisition process often takes 5 to 8 months. Roughly half of that time is spent building and narrowing a pipeline of opportunities and the other half is spent in negotiations and due diligence.

The Takeaway

If acquisition is part of your 2021 growth plan, start now. Assemble your team, refine your strategy, and run a proactive acquisition process. Waiting around for deals to appear will likely produce limited choices, heavy competition and no results.

For more information on the acquisition search process or to discuss your acquisition strategy, confidentially, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com in our Sonoma County, California office. Exit Strategies Group is a partner of Cornerstone International Alliance.

M&A Advisor Tip: Finish Strong

Begin the sale process while your business is on an upward trend. Buyers pay a premium for businesses with well-defined opportunities and a strong growth story.

Too many business owners get tired or complacent and psychologically retire early, before the sale. In fact, after retirement, burnout is the number two reason business owners sell. Unfortunately, burnout usually leads to declining revenues and reduced leverage in the sale process. Stay focused until the end and sell while you still have energy and enthusiasm for your business.

The fact is, many buyers base their valuations on the financial performance of your company over the last 12 months. So after decades of hard work, waiting just 12 months too long can leave significant money on the table.

For further information on finishing strong or to discuss a business acquisition or valuation need, contact Al Statz in our Sonoma County California office at 707-781-8580 or alstatz@exitstrategiesgroup.com.  Exit Strategies Group is a partner in the Cornerstone International Alliance.

M&A Advisor Tip: Work Yourself Out of a Job

The more your business revolves around you, the more risk buyers see. To increase business value and marketability, build a strong management team.

Work yourself out of the business by developing an experienced, empowered management team. The less the business is dependent on you and your knowledge or relationships, the less risk buyers face in a transition. And less risk translates to a higher sale price. Also, more buyers will be able to buy your company if you have a strong management team, which increases competition and further enhances the probable selling price.

For further information or to discuss your situation or a current M&A need, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com in our Sonoma County, California office. Exit Strategies Group is a partner of Cornerstone International Alliance.

Why Your Business Needs Google Reviews

For many businesses today, online reviews are a differentiator. In the past, people asked for references to vet a product or service. Today, they are more likely to conduct their own research and read online reviews. Google reviews can give businesses a credibility boost, for free. Let’s look at some of the key benefits.

Increased Credibility & Trust

According to statistics, approximately 91% of consumers read reviews to determine credibility of a local business, and 84% say that positive reviews help them gain trust. Without the reviews, that initial level of trust would not have been established. Needless to say, people trust Google. Third party reviews have more credibility and higher value than testimonials posted on a company’s own website.

Improved Business Conversions

Once a potential customer gains trust in your company through Google reviews, it is more likely that an inquiry will convert to an actual customer.

Customer Feedback Loop

Customer reviews Google educate your future customers and serve as a feedback loop for you when things need improvement.

Increased Online Reputation & Visibility

The power of online marketing methods that you might be using to promote your business will be amplified, as 5-star reviews attract online users and increase traffic to your website.

Be aware that clients will review your company whether you want them to or not. If you fail to set up Google reviews, you’re missing the opportunity to gain a level of control and visibility.

How to Set Up Google Reviews

  1. Create a Google My Business account. – Visit https://business.google.com. Complete the setup process by filling in email, phone number, business details, etc.
  2. Ask clients to review your services. – Start sharing your Google My Business URL with clients, and ask them to post a review about your company. When asking clients for reviews, you can mention that their review will help everybody else make an informed decision when they are looking for help. It is important to ask for reviews within a few days of completing a sale. As time goes by, clients become less motivated to post reviews.
  3. Remind clients. – Everybody is busy. Your client might forget to write a review. You may have to politely remind them and ask if they need any help posting the review.

Through the above process, you can begin generating online reviews for your business. Of course, it goes without saying that you can only guarantee good reviews when you are delivering top-notch products or services and excellent customer service.

Copyright: Business Brokerage Press, Inc.

Use Equity Incentive Plans to Boost Exit Value

Closely-held business owners often use equity and equity-like programs to attract, retain and incentivize key employees to boost profits and build enterprise value. These plans provide value to the employees through current profit sharing and/or future equity appreciation. I am a big believer in utilizing these types of incentives as part of an exit strategy. Let’s break this down.

Why profit sharing for key contributors?

  • Sharing company profits with key employees incentivizes them to put forth more effort, think more holistically about the business and be more productive, this quarter or this year.
  • For the company, profit sharing shifts compensation from a fixed to a variable expense and aligns the employee’s short-term interests with its own.
  • The company can track, calculate and compensate employees on the performance of the whole company or a smaller business unit (e.g. regional office) when appropriate.
  • Often, profit sharing all that is needed to attract and retain top talent. However, by itself, profit sharing isn’t an incentive to create value for company shareholders.

Why equity appreciation incentives for key contributors?

  • Equity plans encourage longer-term thinking and behaviors that increase enterprise value.
  • Allows employee to defer compensation into the future, assuming there is an exit strategy!
  • Creates incentive to stay, if the company has increased in value.
  • Allows the company to conserve cash needed for growth (vs immediate compensation).
  • Rewards employee for betting on a new or unproven company, when applicable.
  • Helps company compete for talent, both with private “tech” companies that grant stock options, and with public companies that promise more opportunities for career advancement but rarely offer equity appreciation incentives except to the very top executives.

Equity Incentive Plan Options

These plans include “Qualified” Incentive Stock Options and Non-Qualified Stock Option plans. Qualified means the plan qualifies for favorable tax treatment by the IRS.

Stock Appreciation Rights (“SAR”) plans grant a right to employees to receive compensation if and when the company is sold, based on the increase in value over some base value (strike price). The employee pays ordinary income tax on the gain when realized. The rights typically vest over some period and are subject to continued employment. SARs do not pay dividends and holders receive no voting rights. It is common (but not required) to have both a profit-sharing plan and a SAR plan.

Phantom Stock plans are similar to a SAR plan. One key difference, I believe (I am not an expert in this), is that phantom stock plans usually pay dividends on the vested portion (like actual shares), which effectively adds a profit sharing component.

I’m barely scratching the surface of this subject. If you are considering creating an equity incentive plan for key employees, it is critical to work with an attorney that specializes in this area. Jonathan Rubens, a partner in the San Francisco-based law firm of Moscone Emblidge & Rubens LLP, is one of the best. Read Jon’s article: Equity Incentive Compensation and Succession Planning Part I: Stock Options and other Structures for the Closely-Held Business

When your ultimate goal is to sell the company, you have to think about how potential buyers will view the plan(s). It is exceedingly difficult to take benefits away from key employees and keep them happy. The buyer will likely have to continue a profit-sharing plan or replace it with some other form of compensation. This just means that your plan has to produce the desired effect – an incremental boost in sales, earnings and net cash flow. You have to get this right!


Al Statz is President and founder of Exit Strategies Group, a leading California-based M&A advisory, valuation and exit planning firm with decades of experience. For further information or to discuss your exit plans, confidentially, contact Al Statz at 707-781-8580.