Tuesday, March 19, 2013

Preparing for the Unprecedented Transfer of Wealth to Come

Implementing an effective value enhancement program will increase the attractiveness of your business to a potential purchaser and provide a significant return on your investment.  Implementation, however, is the key.  Many business owners appreciate the importance of a good action plan, but successful business owners excel at implementing the action plan.
"According to CIBC, an estimated $1.9 trillion in business assets are poised to change hands over the next 5 years, $3.7 trillion over the next 10 years – the biggest transfer of Canadian business control on record." [1] 
The increasing supply of businesses for sale over this time period will create a buyers’ market putting downward pressure on sale prices.  Without the implementation of a proper plan, business owners will find themselves selling for a significant discount to those that come to market prepared.  Your business exit and continuation plan should address, among other things, how to enhance and maximize the value of your business. 

At VSP, we have developed a 6-step process that provides business owners with a systematic and effective approach to increasing the value and salability of their business.  It is, however, a process and it does take time.  Therefore, it is vital to begin the process at least 3 to 5 years prior to the intended exit.  The 6 steps are as follows:

 
Value Enhancement Step

Description
1.Benchmark business valuation-  Independent baseline valuation
-  Potential purchaser perspective
-  Meeting to discuss valuation
2. Detailed value driver analysisComplete Sellability Score questionnaire
-  Detailed management interview
-  Value factor analysis
3. Prioritize the key value driversEach value factor is rated in terms of its relevance and impact
-  Identify top 5 key value drivers
-  Meeting to discuss key value drivers
4. Develop action planStrategic planning session to identify goals and brainstorm obstacles
-  Identify strategies to overcome obstacles
5. Implement, monitor and follow-upAssign tasks and responsibilities to key individuals
-  Develop short-term targets/objectives
-  Quarterly meetings to monitor progress
6. Updated business valuation Updated business valuation to measure progress

Steps 1 to 4 can be completed within a very short period of time.  The implementation under Step 5 will vary depending on the owner’s time horizon.  Step 5, however, is the crucial step as it is the ongoing quarterly meetings that ensure the implementation of the action plan.
 
To illustrate the significant return on investment of an effective value enhancement program, let’s consider a business with revenues of $4.0 million and after-tax cash flow (pre-debt service costs) of $400,000.  With a current multiplier of 4.0 times (i.e. 25% capitalization rate), this would imply an enterprise value of $1.6 million (i.e. $400,000 x 4.0 times).
 
Now let’s assume that the business invests $40,000 in professional fees over a two year period (i.e. $20,000 per year, or 5% of annual after-tax cash flow) towards the above noted value enhancement activities.  Let’s also conservatively assume that the value enhancement program leads to an increase in the valuation multiple from 4.0 to 4.5 times (which does not take into consideration any increase in value associated with an increase in annual cash flow or a decrease in the outstanding debt).  The enterprise value of the business has increased to $1.8 million (i.e. $400,000 x 4.5 times), or an increase of $200,000.
 
With an investment of $40,000 over a two year period and an increase in business value of $200,000, this represents a return of 500%.
 
You may not be looking to exit your business in the coming year.  However, if you are planning your exit within the coming decade (i.e. alongside over 500,000 other business owners in Canada) and would like to maximize the price you receive, you must begin your planning now.  Contact us at www.vspltd.ca to help develop a targeted value enhancement program and work with you to ensure a successful implementation.
 
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1.  Ottawa Citizen, November 13, 2012. 

 

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