The majority of valuations that come across my desk, bring to light obvious areas of opportunity for business owners to make improvements and over time increase the business value, otherwise known as the low hanging fruit. However, who are these areas of opportunity obvious to? The business owner? The valuator? A potential buyer?
It’s all about what perspective you are coming from.
The Business Owner. A business owner, in the lower middle market, generally wears multiple hats. Managing daily operations, quoting bids, hiring employees, going client’s offices, etc. They work in the business, are generally the go-to person for any issues company-wide, and hold the key relationships with the clients/customers. The business owner is so busy working in the business they may not realize the low hanging fruit even exists. “A wealth of information creates a poverty of attention,” economist Herb Simon warned in 1971 and this is even more true today with the ever increasing access to data at our fingertips.
It is not uncommon for business owners run their operations in this manner. By no means is this wrong. In many cases, it’s a lifestyle business. Owners grow the business to a certain size and then manage it until they are ready to exit. Usually this happens after the owner has burnt out. This may be the result of the lack of a management team and not being able to delegate responsibilities. The business could be strapped for cash because their customers are paying in 60 days instead of 30, the business has inventory to purchase, and bills are due. Working in the business instead of on the business also brings out a reactive management style. Business owners put out fires as they come across their desks instead of strategically planning where to take the business or solve long term problems. Whatever the reason for burnout is, it is usually precipitated by a buildup of stress, making retirement look like an escape.
Unfortunately, when burnout sets in, the low hanging fruit usually signify more work to an already tired business owner. Choosing to pick the fruit would mean having to put more time and effort into the business they may have already mentally checked out of rather than an opportunity to achieve higher value. On the other hand, letting someone else take advantage of the fruit could mean a faster sale but will certainly result in less money at the closing table.
The Potential Buyer. When a potential buyer is evaluating a company, they are determining how risky of an investment it is and exploring whether there is low hanging fruit that can be plucked to mitigate those risks. Different types of buyers bring different strategies and skills. For example, a large strategic company would be an ideal acquirer for a company whose owner wears multiple hats. More than likely the acquirer would have divisional managers that could handle the cross-functional jobs the previous owner was performing and would not have to hire for all those individual responsibilities. Another example would be a Private Equity Group acquiring the company who needs operational efficiency with their working capital. PEGs will often provide their expertise along with financial backing to correct inefficiencies within the business.
Buyers beware! Low hanging fruit is not always a welcome sight for buyer’s eyes. Savvy investors will always dig into the financials and background of the companies to see if there is more risk to be uncovered. Opportunities carry an inherent opportunity cost, and the fact that the current owner has chosen not to pursue an “obvious” opportunity will give an investor pause as to how realistic the proposed return will truly be. The more items in the negative column, the less buyers who stick around to submit offers.
The Valuator. No matter who he/she was hired to represent, the valuator should remain neutral throughout their fair market assessment of the company. The IRS Revenue Ruling 59-60 defines Fair Market Value as:
“the price at which property would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, with both parties having reasonable knowledge of the relevant facts.”
The valuator needs to look at the company from all perspectives; what is good about the company, what could be improved, and what is beyond its control. This is the fine art valuations. Assessing the assets of the company, weighing the risks and determining the near term future of the market. This, of course, includes placing a risk factor on the low hanging fruit which will affect the overall value of the company.
The market today is good and multiples are still strong. That could change next month or next year, no one can predict that with any certainty. No two businesses are run the same way and no business is perfect. Every business has opportunities for improvement, even ours. Having a valuation done periodically will help you identify those areas for improvement. When the time comes for you to transition out of the business you will have captured that low hanging fruit and you will have more money in your pocket at the closing table.