The Biggest Mistake An Owner May Make

1
The Biggest Mistake An Owner May Make

• Issues In Selling A Business
• Tom Long
• Harley Mullins

2
I Want To Sell My Business

• Is your client troubled by lack of growth?
• Are they concerned the value of the business will
  not be enough to support them when they retire?
• Are they losing sleep over the fact that most
  small business are not saleable at the time the
  owner chooses to transition?

3
Owner Issues

• Recent studies show that 85 of the business
  owners have no exit strategy
• Further, these owners have 75 of their net worth
  tied up in their businesses
• Most business owners try to sell to another
  owner-operator
• They may be leaving a considerable amount of
  money on the table

4
42 to Exit Within 3 Years
Revenue and Value-Added Service Opportunity

• Valuation and Growth Strategy Implementation
• Internal Process Standardization
• Financial Planning
• Debt Re-Structuring Growth Capital

Raymond Institute Family Business Survey
5
Consulting Opportunity

• Even an owner that is ready to sell right away
  represents a BSP opportunity.
• Many owners are interested in taking action that
  will increase business value over the next
  several years in preparation for selling.
• Working with a business owner on the basis of
  business value represents a long-term perspective.

6
You Cant Be Better Unless You Are Different

• Its About Offering More Value-Added Services
• Its About Being Sought Out vs. Waiting for
  Referrals
• Its About Differentiating Yourself!
• Its About Competitive Advantage!

7
Competitive Advantage Value Proposition
Exit and Transition Planning

• Strategic Positioning
• Value Enhancement
• MA Representation Buyer Sourcing
• Financing

8
Our Mutual Goal
9
Total Solution Consulting

• Mitigating Risk
• Creating Differentiated Value
• Positioning to Attract the Right Buyer
• Maximizing Exit Value

10
Because a Business Has Value Doesnt Mean It
Is Salable It Must Have a Competitive Advantage
11
Defining Value

• Risk versus Reward

12
Risks

• Age of Business
• Management layers
• Employee Turnover
• Account Concentrations
• Location Lease Terms
• Financial Trends
• Fixed to Variable

• Legal Issues
• Competition
• Size of Market
• Owner Dependency
• Supplier Dependency
• Environmental
• Life Cycle
• Industry concentration

13
Value Decreases With Age
Where Is the Clients Industry?
Extending the Life Cycle is the Key
14
Mature Industries 80of the Market

• Increasing Risks
• Limited or No Competitive Advantage
• Value is a Function of Risk
• Competitive Advantage
• and Positioning

15
Buyer Types

• Owner Operator Buyer
• Financial Buyer Private Equity Group
• Strategic Buyer
• Management
• Foreign - International

16
Positioning

• Determining the Buyer-Type
• That Will See the Most

17
Lost in the Woods

Appraised Value tells you where you are
Strategic Positioning Shows you the Way out
Where Price Exceeds Value
18
ABC MACHINE MFG CO.A CASE STUDY
HJM BUSINESS SOLUTIONS

• BizMACH
• BEST ONE REPORT

19
Case Study ABC MACHINE MFG

• THE OBJECTIVES OF THE EVALUATION
• THE OWNER IS 55 YEARS OLD AND WOULD LIKE TO SELL
  THE COMPANY AND RETIRE.
• THERE ARE TWO EMPLOYEES THAT HAVE EXPRESS A
  DESIRE TO PURCHASE THE COMPANY. THESE EMPLOYEE
  HAVE NO BUSINESS MANAGEMENT EXPERIENCE.
• THE OWNER IS LOOKING AT A COMPANY VALUE OF 500K
  TO 600K GROSS TO COVER DEPT BOTH COMPANY AND
  PERSONAL AS WELL AS TAKE AWAY ENOUGH TO RETIRE.

20
OPERATIONAL OVERVIEW

• The company is a single shift contract machine
  manufacturer. Services include CNC turning and
  milling, general machine work, welding,
  fabrication, assembly and prototype work.
  Industries served include Heavy Equipment,
  Military-Aerospace, Steel, Material Handling,
  Cranes, Energy, Testing and Food Industries. The
  owner handles all sales, marketing and finance
  related responsibilities.
• Pricing
• The company accountant performed a
  price-cost analysis and recommended a new shop
  rate of 55.00 per hr. Overtime has been running
  around 37 hours per week.
• Growth Opportunities
• The present management believes that there
  may be new avenues for growth in government
  contracting and additional work from existing
  industries.
• Company's Most Pressing Problems
•   1. Finding qualified machinists 2.
  Increasing Sales and Profitability 3. Owner's
  time in the shop

21
Management Employees

• 
  
• 
  Owner
• Duties Number of Hours 80 Hr.
• Administration Financial-----------------2
  5
• Production----------------------------------
  ---40
• Sales Marketing---------------------------
  10
• Other---------------------------------------
  ------5
• Total----------------------------------
  -----------80
• Employees
• No. Full Time- 4 Wages
  18.00/Hr.
• No. Part Time- 0 Wages
  14.00/Hr
• Quality of Employees-low Turnover, Well Trained
• Benefits Health Insurance-Full Time only
• Paid vacation Holidays
• No Pension Plan

22
CUSTOMERS DATA

• Account Concentration
•  gt 30 from two customersX15 - 30 from 2 or
  fewer customers10 - 14 from one customer No
  Concentration 
• Note Approximately 70 of the company's sales
  are from two customers
• Both customers have 15 - 22 year relationships
  with the subject.
• Percent of Business Considered "Repeat"
• 90

23
CUSTOMER DATA

• Customer Base -- Established Base - Moderate Buy
• Major Industry Segments Served
• Government 10
• Industrial 90
• Seasonal Sales Trends?--- None
• Internet Based Sales 10

24
Income Producing Assets

• Current Assets  
• Cash13,655
  
   Accounts Receivable 61,937  
  
  
• Inventory  
•  Raw Materials10,500  
• Work in Process 6,000
• Inventory Total16,500     
• Current Asset Total 92,092     
• Fixed Assets - Owner's Market Value  Equipment209
  ,500  Vehicle 3,500  Fork Truck 3,500
•  Total Fixed Assets216,500    
•     Current Liabilities  Accounts Payable50,025
      
• Net Working Capital42,067
•  Note Equipment Lease Liability of 2,983.53 mo.
  for 30 months

25
Gross Profit Analysis

• 
  2001 2002 2003 2004 
•  
• Orland Revenue 787,000 660,000 622,000
  771,000
• Cost of Goods 569,029 425,981 391,906
  399,131
• Gross Profit 217,971 234,019
  230,094 371,870
• as of Sales 27.70 35.46 36.99
  48.23
• Cash Flow 10,639 47,989
  409 57,471
• 
  

26
Discretionary Cash Flow Analysis

• 
  2001 2002 2003 2004
• Net Income (71,530)
  (37,888) (5,076) 22,129
• Interest Expense 13,796
  76 12,553
• Depreciation Equipment 76,596
  45,860 27,410 16,273
• Supplies
  5,176 22,948 2,632 1,555
• Supplies Adjustment (5,000)
  (5,000) (5,000) (3,333)
• Equipment Lease 22,023
  33,169 0 0
• Equipment Finance Assumed(35,769) (35,769)
  (35,769) (35,769)
• Personal Automobile 5,361
  5,972 4,813 2,539
• Owners Draw
  58,697 51,323 69,601
• Administrative Replacement
  (40,000) (40,000) (40,000)
• Discretionary Cash Flow 10,639 47,989
  409 57,471

27
Notes

• Note 1. Net Income taken from Tax Returns in 2001
  thru 2003 and from the internal PL for 8 months
  in 2004
• Note 2. Interest expense will not carry over to
  the buyer since seller will pay all bank debt
• Note 3 Depreciation is a non-cash expense
  allowed by the IRS for the re-capture of capital
  expenses made in the past
• Note 4-5 Supplies were stabilized at 5,000
  annually and adjusted in each year accordingly
• Note 6 Equipment lease payments made by the
  company in all years were added back to cash
  flow.
• In discussions with the company accountant,
  equipment leases expired in 02 and were
  refinanced in 04. Therefore, there is no lease
  expense in 03 and the refinance of equipment
  resulted in "interest expense" in 04
• Note 7 Proposed assumption of GE Lease at 2,983
  a month inserted as a negative adjustment to cash
  flow
• Note 8 Personal automobile expense seen as a
  discretionary expense of the owner
• Note 9 The company accountant acknowledged that
  approximately 90 of Office Wages were paid to
  the owner. There were no W-2s available to verify
  this and as such this item should be verified by
  W-2s for each year
• Note 10 Administrative replacement for owner to
  handle administrative functions, office and
  financial details, which have been handled by the
  owner.
• Note 11 No salary adjustment was made for the
  new owners since they are presently employed at
  the company and their wages are already included
  in direct labor

28
EVALUATION SUMMARY

• Weighted Multiple of Earnings Method      
• 2004 Projected Cash Flow
  57,471
• Multiplied by Capitalization factor
  1.80
• Value of Cash flow
  103,447
• Add Net Working capital
   42,000  
•  Add Excess Working Capital
  (38,000)
• add fixed assets at Owner's Value
  213,000
• WME Value
  320,447
•      
• Capitalization Method  
• 2004 Projected Cash Flow
  57,471
• Capitalization Rate
  0.676
• Capitalization Value
  85,072
• Add Excess Working Capital
  (38,000)
• add fixed assets at Owner's Value
  213,000
• Combined Capitalized Value
  260,072  

29
EVALUATION SUMMARY P-2

• Net Asset Value
• Net Working Capital 42,000
• Owners Fixed Asset Value 213,000
• Net Asset Value 253,000
• EBITDA Multiple 57,417 X 4 229,884

30
ANALYSIS OF VALUE

• The value of this company to the purchasing
  employees is approximately 275,000 to 300,000
  based on the continuation of 2004 financial
  trends, however the likelihood of sale to the
  employees is very low unless the buyers have
  sufficient cash and the seller is prepared to
  hold a note, the combination of which equals the
  selling price.
• Third party bank or SBA financing for this
  deal is doubtful for many reasons
• Financial trends
• Lack of sufficient, stable cash flow
• Account Concentration Risk
• Owner control over business and his relationships
  with customers
• Lack of buyer's management experience
• Need to add administrative support
• Need to add sales personnel

31
ANALYSIS OF VALUE

• Recommendation
• If this company is to be sold immediately, we
  recommend a consolidation sale (horizontal
  integration) to a competitor that has excess
  capacity and could absorb ABCs customer base
  with little difficulty. Based on a projected 2004
  gross profit of 300K to 370K, it is conceivable
  that the right competitor might pay between 450K
  to 600K for the ABC Sales Volume based on final
  gross profit performance.
• Because 70 of ABC sales are concentrated between
  two customers, the buyer may opt to split the
  price into two increments a cash piece and a
  contingent note payable after some time period
  when retention of these two accounts seems secure
  (6 to 12 months). This structure could be
  negotiated to include a lower purchase price for
  cash only.

32
EXAMPLE

• Suppose the two-tiered, cash/note price of
  600,000 is negotiated whereby 400,000 is
  payable in cash at time of closing and 200,000
  is payable over 36 months based on the buyers
  ability to retain the two largest accounts beyond
  6 months. There would be a pro-rated adjustment
  for any loss in sales volume from these accounts
  i.e. a 20 loss in sales from either or both of
  these accounts would mean a 20 reduction on the
  200,000 note or (40,000). Therefore, the buyer
  would make note payments based on 160,000 for 36
  months. There is a strong probability that any
  sale of this nature and structure will probably
  require a 3 to 6 month employment agreement
  between the buyer and seller to insure against
  revenue fallout.

33
Thank You
QUESTIONS?