After being involved with many business transactions over many years, I’ve realized that there are at least seven ways that potential investors look at a business. Not every investor will look from every perspective. There are, of course, financial buyers and strategic buyers, and their perspectives will likely not be the same and not all perspectives will be relevant for every company. However, these various perspectives are worth discussing for your consideration.
How Do Investors Look at Businesses?
A number of years ago, I gave a talk to a group of business owners and was asked to address the question: How do investors look at businesses? They were not looking for specifics about profitability or margins or growth, but in general categories to facilitate their thinking. My first list had five perspectives and the list has now been expanded to seven. If you can think of other broad perspectives that I have missed, please let me know. Here goes.
- At a point in time. Your company’s current balance sheet is a representation of the financial position of your business at a point in time. However, understanding where you are at a point in time is far more than taking a look at your balance sheet. After all, the next perspectives entail financial analysis that will pick up your financial position. Investors want to know more than financial position. They will want to visit your company and make a general assessment of how things look and even, on the softer side, “feel.” How does your company present itself to the world? What is the state of your website? What are first appearances when coming to your offices? Your distribution facility? Your manufacturing facility? What is the appearance of any rolling stock or equipment used in your business. For service companies, are your employees using current technology? What is the state of your operating and financial systems? Current? In need of upgrading or replacement? Do you have any significant customer concentrations? Product concentrations? Supplier concentrations? And on and on. As you can see, there are first impressions regarding your business at a point in time and there are deeper impressions. It is important, then, to think like an investor as you look at your company currently. After all, you and your fellow owners are the current investors! So what is the condition of your company now, at this point in time?
- Relative to itself over time. The beginning point of any business valuation is a financial spreadsheet analysis examining your business relative to itself over a period of years. What trends are reflected on your income statements? Are sales growing, flattened out or declining? Are margins stable or improving? What is happening with your top ten or twenty customers? What is happening with your top products or services? Are you creating new products and new services that are reflected in your income statements? What is your current financial position in relationship to your recent past? Is your balance sheet excessively leveraged? How have your recent operations been perceived by your current lender(s). Do you have excess assets on your balance sheet that no one other than you wants? How about excess working capital? What are your trends in receivables outstanding? How about payables? If you are thinking like an investor, you will be watching the mentioned trends and others. As the current investors, you and your fellow owners are preparing your business for the next investors, which may be yourselves.
- Relative to peer groups. Peer analysis is all a part of an investor’s overall financial review of a business, but it is important. Are your current margins at peer levels, or above or below? What is the trend in your margins relative to the similar trends with your peer group? If your margins are well-above your peer group, are they convincingly sustainable? Are the above-average margins the result of effective management or competitive advantage of some kind? Investors are concerned with what is called a tendency for margins to experience what is called a “reversion to the mean” over time. If your margins are below peer levels, what is the explanation? If below peer levels, are your margins improving over time? Are there structural issues with your business that are hurting your margins, or are there “fixable” things that can be improved. What you don’t want when you ultimately sell your business is for someone else to experience the favorable “reversion to the mean” that might be available. Most businesses have some means of looking at peer groups, but it is easy to explain away unfavorable differences rather than to do something about them. As the current investors, you and your fellow owners are looking at your relative performance, so are you acting to sustain advantage or to improve relatively adverse performance trends? The next investors will certainly do this.
- Relative to budget or plan. Most successful and sizeable businesses have some form of operating budget or operating plan on an annual basis. How do you perform, over time, relative to your budget or operating plan? Let me illustrate from an experience in a litigation regarding business value. The other expert advanced a higher valuation conclusion in reliance on “management plans” for aggressive growth. When it was pointed out to the court that the CEO had had similar aggressive plans (or wishes) for the last several years that had not been achieved, the valuation question was resolved based on then current operations and a reasonable outlook for the future. The next investors looking at your business will ask to look at your performance relative to plan in the past. After all, you will want them to believe that they can experience a favorable future. Or, as in many transactions in the current environment, they may ask you to maintain an ongoing interest in the business. In any event, all investors are or should be interested in performance relative to plan, and in understanding reasons for significant under- or over-performance.
- Relative to your unique potential. Many business owners want to believe that their companies are unique in the marketplace. Most companies, however, while they may be different in some ways from competitors, are not unique in the sense of “one-of-a-kind uniqueness.” But if your company indeed has a unique brand advantage or other competitive advantage, investors will want to understand it – and you will want them to price that advantage into any offers.
- Relative to strategic or synergistic opportunities your platform offers. When presenting companies to strategic investors, we always attempt to estimate or to anticipate the kinds of benefits that a client company might afford to them. The fact is that strategic or synergistic investors can view your earnings stream differently than you can as the current investor. There may be cost benefits from purchasing advantages or the ability to consolidate a portion of operations into larger business units. There may be revenue benefits from the ability to sell their products through your distribution channels or to sell your products through their channels. There may be other benefits, as well. If so, we want to highlight the cash flow difference in order to attempt to negotiate the benefit of all or a portion of that benefit for the current investors. Not all companies are sold to strategic buyers. However, as the current investors, you and your fellow owners want to be aware of these potential benefits, if they exist.
- Relative to regulatory expectations or requirements. For regulated companies like banks, insurance companies, many utilities and others, regulatory requirements establish certain operating rules that must be followed. The next investors for your business will obviously be aware of these requirements, if applicable. For other companies, however, these regulatory requirements may affect your business in the form of pension liabilities or environmental liabilities. And all future investors will want to know that you operate your business in compliance with all applicable laws and regulations, just as you want to know this as the current investors.
So there are at least seven perspectives that will be used by any future investors in your business to examine and analyze in their decisions to make investments in all or a portion of your stock.
What to Do Now?
Forewarned is, as they say, forearmed. I’ve written this post from the viewpoint of future investors who may look at your business. But we have also talked about you and your fellow owners’ perspective as the current owners of your business. If you now have an overview of how future buyers will look at your business if and when you decide to sell, doesn’t it make sense to engage that future view in the present?
How can you do this? One way would be to have a qualified appraisal firm with transactional experience conduct a valuation analysis of your business that is geared to address the seven perspectives of future investors in more depth than might be employed in a typical appraisal. That analysis could highlight opportunities to reduce risk, and to enhance expected cash flow and growth. In a recent post, I outlined the benefits of periodic appraisals for closely held and private businesses:
Annual Appraisals and Monitoring of Performance. Liquid assets are valued every day, and portfolio performance reports are made at least quarterly for most portfolios. Annual valuation is the best way of tracking investment performance over time, and for reporting to shareholders about a company’s return performance relative to itself and to other asset categories.
I have been advocating the benefits of annual, or at least periodic, appraisal of businesses for more many years. When I speak to business owners I sometimes joke and say that in the early years, I encouraged annual appraisal because it would be good for my business. Now, after many years of working with private businesses, I unabashedly make the recommendation because it is good for their businesses and your business as well. We now provide annual appraisals for more than 100 companies. Some of these companies have been clients for 25 or more years. There is clearly value in the process.
Buy-Sell Agreement Pricing. Annual valuations can also establish the value for buy-sell agreements. They are so important that I have written a print book and an Amazon Kindle book about these critical and oft-ignored business agreements. In fact, the valuation process I most often recommend is that a single appraiser be agreed upon and employed to provide an initial valuation for buy-sell agreements, and then that the appraiser will provide annual revaluations to revalue the price for the buy-sell agreement. Note that the annual appraisal for purposes of your buy-sell agreement would serve multiple purposes.
Any well-crafted appraisal will address the key issues outlined above. If you are not obtaining an annual (or periodic) appraisal, now is a good time to start. If you contact an appraiser, it would be good to begin with an in-depth valuation analysis like that outlined above as a starting point. If you are already obtaining regular appraisals, it would be a good idea to ask your appraiser to conduct a more detailed valuation analysis from the viewpoint of future buyers. That analysis might be a separate document from your regular appraisal.
So we have talked about “7 Ways Investors Look at Your (or Any) Business” from two perspectives now. First, we talked about how future investors might look at your business. That’s instructive because, as discussed earlier, you will transfer your business ownership, either in whole or in part, and either voluntarily or involuntarily. So future investors will be looking at your business.
We have also talked about these seven investor perspectives from the viewpoint of you and your fellow owners as current investors.
If future investors will assuredly be looking at your business from these seven perspectives, it is a pretty good idea for the current investors to do the same, at least periodically, and to make course adjustments if you see issues that would detract from future value from their perspective.
As always, if you wish to talk with me about any business or valuation-related matters, or to discuss management or ownership transition issues in complete confidence, give me a call (901-685-2120) or email (email@example.com).
Until next time,