Company Value Optimization

Observations from our Founder and

Managing Director

Topic: A Solitary Focus on P&L Penalizes the Value of the

Enterprise

A consultant that is a non-employee C-suite member can be a

catalyst for a company developing two focuses: The P&L, and

the value added to the balance sheet and goodwill (asset) of the

company.

The corporate officers (C-suite) of any company have many

priorities:

Balancing income and expenses, investing for growth while

maintaining cash reserves, preparing for a downturn in the

economy or an unforeseen “black swan” event such as a supply

chain interruption, all while seeking to add quality staff to

support service or product delivery contracts.

The priorities for “today” often crowd out the requisite hard

work of building true value in the enterprise. The result?

Without adequate sales next quarter, the business suffers.

Without adequate sales for two quarters, the business faces

forced cutbacks. Without adequate sales for three quarters, the

business faces an erosion of its assets, likely capital calls or

infusion of capital, or the potential of a shutdown.

Optimizing the Value of a Business Enterprise Typically

Has Three Focuses:

1. Today’s profitable operation delivering net profit margins on

the P&L.

2. The pipeline of new or repeat business for next quarter and

next year, with predictable profit margins and the requisite

team to deliver the product or service.

3. Growth of tangible assets in the balance sheet, as well as

growth of intangible assets that are not on the balance sheet,

but form the asset notated as “goodwill.”

Goodwill is so important that the IRS separates it from the

business assets and allows special treatment for both the buyer

and seller. What comprises goodwill? The value of the brand

reputation of the enterprise to garner future business. The

forward book of business that is in the bid process but not yet

closed, and the skillset, experience, and reliability of the

employee team expected to remain after an acquisition.

Goodwill also encompasses the company’s relationships with

the community, its banking partners, and its broader industry

vertical. It includes intellectual property that has been filed or

granted, trade secret formulas and proprietary designs recorded

on the balance sheet at acquisition or cost rather than marked to

market valuation, and the internal processes that improve

efficiency and profitability. It further extends to the

organization’s protocols, training manuals, orientation

programs, and operating manuals that preserve institutional

knowledge and ensure consistent execution.

Base Hits vs Home Runs

Optimizing the value of a business enterprise has always, and

will always require a dual focus: today’s business, and

tomorrow’s business.

If the founders focus solely on today’s business, even with

diligence, they have potential to make a “good living” but are

not necessarily building long-term “business wealth” for an

exit down the road. Typically, businesses with this “today”

focus often shut down when key team members depart, or are

sold at the value of their accounts receivable (AR) and

contracts on the books, or at best, for a small premium over the

assets on the balance sheet.

Alternatively, it is possible to maintain focus on today’s

business while developing a deliberate strategy to add

long-term value positioning the company for a sale or merger

down the road.

Building Enterprise Value as a Co-Priority with P&L

To add enterprise value to the core business, a business must

make valuation a co-priority with P&L. Factors and metrics

that are used to determine that a business is healthy and

growing in value become the priority. Examples include:

1. Positioning for long-term, multi-year contracts rather

than short-term contracts.

2. Focusing on a larger number of recurring customers

rather than concentrating on a handful of customers.

3. Paying founders and key employees reasonable base

salaries consistent with the industry standards and

increasing their compensation through the distribution

of excess earnings or dividends.

4. Utilizing traditional business health measurement

metrics and ratios to analyze current operations in

relation to private and public company metrics for the

specific vertical.

Every C-suite has a current and ongoing responsibility to take a

position fix on the true current enterprise value of the business,

and assess the factors that impact that valuation in the future.

A Brief, Though Not Complete List of Factors and Metrics

Impacting a Business Valuation Includes:

1. Past, current, and projected profit margin

2. Market penetration, current and future

3. Return on capital

4. Free cash flow

5. The forward book of business

6. The concentration of customers contributing to the gross

income (IE: dependency on one customer contributing a large

percentage of the gross income is a perceived vulnerability)

7. Accounts receivable (A/R) aging

8. Debt-to-equity ratio

9. Inventory-to-gross-income ratio

10. Inventory turn, and the capital necessary to support the

inventory

11. Historic, current and potential EBITDA

12. Balance sheet analysis of equity, current and long-term debt

13. Paid-in capital necessary to support current business versus

past mismanagement

14. Terms of long-term debt, short-term debt, and changing

ratios

15. Potential liability (product or service) whether reserved or

not reserved

16. Employee contracts (duration)

17. Age of intellectual property (IP) patent grants

18. Current and prospective competition in the vertical

19. Potential for the business model to be displaced by current

or future technology or

impacted adversely by a major federal or state law change (IE:

think solar farms or EV

sales contraction)

20. Gross and net revenue per employee, year-to-year analysis

21. Current or prospective impact of regulations on the vertical

as well as the overall business operations

22. Ongoing capital expenditures necessary to sustain the

business operations

23. Macro economic factors likely to impact the net operating

margins (IE: interest rates,

labor cost increases, inflation, tariffs, insurance costs, liability

claims, class action

lawsuits, failure of supply chain participants to maintain their

business enterprises, public sentiment change, political fallout)

24. Contingency plans for the death or incapacitation of the key

employees

25. Contingency plan for the impact of the death of a founder

forcing a generational ownership transfer

26. Any “act of God” that could adversely impact operations

(Floods, tornados, civil unrest)

Valuation Differentiators and the Role of Goodwill for

Illustration Purposes

Given the following descriptions, which company would

command the premium dollar from a buyer seeking to expand

its business through acquisition?

If two engineering firms, both in the same MSA, each grossing

$5M a year, each with four founders and twenty support

employees or subcontractors, and each netting $1M a year to

the founders, are up for sale, what factors differentiate the

perceived value?

Firm A has over twenty customer contracts per year, and five

of its customers have entered into five-year exclusive contracts

with the firm to support the roll-out of their franchise

operations year by year. All employees, including the founders,

have employment contracts and executed NDAs. Firm A has

maintained professional liability insurance on each project.

Firm B has four clients, two of which are green energy

companies dependent on government funding for projects to

progress, one of the remaining clients a municipality, and the

last client is a big-box pharmaceutical start-up company. There

are no multi-year exclusive service contracts. Twelve of the

twenty staff members are independent contractors. There are no

employment agreements, or NDAs in place, and the firm

allowed its professional liability policy to lapse because, as

they put it, “they never had a claim.” Firm B has no business

booked for the coming year but reports multiple “potentials.”

With no other factors revealed, which business has greater face

value and will likely command a higher offer from the Buyer?

Firm A is clearly in the superior position. Its diversified client

base, recurring contractual commitments, and comprehensive

employee protections all contribute to stability, predictability,

and reduced risk three factors that drive premium valuations.

Firm B’s reliance on a narrow customer base, lack of long-term

contracts, and exposure to uninsured risk make it a

significantly less attractive acquisition.

A consistent focus on building value to optimize company

valuation does not happen accidently. Unfortunately, many

founders spend years building a business that provides a good

income for the founders and C-suite members, but without ever

establishing an exit goal or strategy for the eventual sale of the

enterprise.

Two concurrent focuses are essential: build and maintain a

healthy day-to-day business operation, and, where possible,

implement strategies to build the all important asset of

goodwill. Profit sustains the business; goodwill sustains the

enterprise. The most valuable companies are those built with

both in balance.

— From the Office of the Managing Director