Talking Industrial Automation Encore Presentation: Business Value: GPS for Your Business PostedTuesday, July 19, 2022 at 1:05 PM This is a partial transcript of the Talking Industrial Automation episode that featured an encore presentation of a CSIA MasterClass that was originally published on the CSIA Website called Business Value: GPS for Your Business. The panel was moderated by Bryan Powrozek of Clayton & McKervey. Panelists included Clint Bundy of The Bundy Group, Ben Smith of Clayton & McKervey and Jane Tereba of Capital Valuation Group. Bryan Powrozek: I am Brian Powrozek with Clayton & McKervey, and I get the honor of moderating today’s panel. Working with a lot of different system integrators on their businesses, one of the things that we often get asked and get questioned on is in making decisions on their business. Is this the right thing for us, adding this product line, adding this service? And a lot of those questions are very challenging because it’s never a really cut-and-dried answer. We found that if you bring this idea of value into the conversation, it really helps take out some of that emotional component of decisions and gives you something to focus on that’s going to be pretty consistent as you’re going forward. Hence our focus here is “How can a business owner use their business value to guide decision-making, guide strategy, et cetera?” With that, I’m going to have our panelists introduce themselves. Jane, if you wouldn’t mind giving everybody just a quick introduction? Jane Tereba: My name is Jane Tereba. I’m the President of Capital Valuation Group. We are a boutique valuation firm located in Madison, Wisconsin. All we focus on is business valuation, and we can help determine financial damages in a litigation setting. Bryan Powrozek: Clint? Clint Bundy: I’m Clint Bundy, Managing Director with Bundy Group. We are a boutique investment bank and mergers and acquisitions advisory firm. We specialize in representing businesses in one of two major events: either a business sale or a capital raise. Bryan Powrozek: Thank you. Finally, Ben Smith. Ben Smith: My name is Ben Smith. I am a shareholder at Clayton and McKervey. Clayton and McKervey is a full-service CPA firm that has a heavy focus on system integrators. I sit within our consulting practice. Most of what I do centers around transaction support doing financial due diligence and then also leading our digital advisory practice. Bryan Powrozek: Jane, I will start with you. Just so we’re all on the same page, can you give me a baseline definition of business value? Jane Tereba: Everybody knows if you own stock in a publicly traded company, it’s very easy to determine its value, right? You can look at your investment account. You can research the stock online. But as we also know, if you own stock or equity in a closely held company, there is no market reference to determine its value. What we do and what we’re going to talk about today, is how you figure out that business value of a privately held company. When we’re thinking and talking about that today, we’re talking about the price at which that ownership interest would transfer hands or change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of all facts. We’re essentially trying to determine what would be reasonable for that company or that equity interest to transact between a willing buyer and willing seller. Valuation is about two things. It’s about cash flow and risk. The future economic benefits of the company are the cash flows. How profitable will the company be after reinvesting in its infrastructure? And then those future economic benefits are impacted by the risk in the company. The value of your company, the value of the equity that you might own in your company is going to be impacted by the future because a buyer is always looking forward. How am I going to earn a return on my investment going forward? History is great, and it will instruct us as to what the company might be able to accomplish in the future. But it’s all about looking forward and understanding the risks and opportunities within a business model that will be able to support those projected cash flows. Bryan Powrozek: Clint, the next question then will go to you because as Jane laid it out there, the value is usually thought of in some sort of a transactional capacity, right? Somebody purchasing the ownership interest in a business or selling the ownership in a business, and that’s what you do day in and day out. Can you explain the process of selling a business? Can you explain that process a bit and give us some of the different ways that a buyer might look at a transaction versus a seller? Clint Bundy: I will divide this into two parts. First, process, and then give you the buyer versus seller lens. Process at a very high level: I would divide it into three phases: the preparation phase, the marketing phase and then the closing phase. Preparation phase is where the owner and his advisors, whether it be transaction accounting or an investment banking advisor like Bundy Group or your regular CPA firm, and if you have a separate one from your transaction accounting or even your personal financial wealth advisor. Those are all part of your deal team plus a deal attorney. They’re all helping you get ready to take the company to market, to talk to buyers. In our view, the final valuation is determined by a competitive marketing process, which is what we’re usually very involved with in running. So, the preparation, you get all the great – the materials together, the details, the marketing phases. You have buyers signing non-disclosure agreements in your approach, whether it be a small select group or be a broader group of buyers, to generate that competition and interest. There are several milestones you hit within that which – for the sake of time, I won’t get too in the weeds on that. Then you get into the closing phases, where usually about that point have signed a letter of intent with the buyer that you selected and hopefully have done the right way maximum valuation in terms. It’s a great fit buyer and then you complete out the confirmatory due diligence and close the deal. So those are the three phases at a very high-level process. The sellers kind of view – in our experience because we’re representing sellers on this all the time -- is if their angle is help me get the right value, help me get the right fit and help me get this deal done, and, hopefully, do it with as minimal headache as possible because hey, I still got a business to run. The buyer’s view is they want to buy a great company. And let’s be honest. Buyers, most buyers if not all, want to buy the best valuation of them possible. But they do want to get a deal closed. So, you know, at the end of the day, it’s making sure alignment is there for both sides to get a deal done. A friend of mine once said every closed deal is like a mini miracle, and there’s some truth to that. But from the Bundy Group side, our alignment is usually with the seller. So, we want to make sure they land on the best possible position. Bryan Powrozek: Excellent. Ben, building off what Jane and Clint have both already talked about, there’s this transactional component when you’re talking about business value, right? In the work that you’ve done, what are some other ways that business owners can use this concept of business value more strategically rather than just focusing on a transaction? Ben Smith: When I talk to business owners, oftentimes they have a fuzzy definition of what value is or they have the baseline down that Jane mentioned earlier where it’s about cash flow and it’s about risk. But what they might not realize is there are six to eight different levers, depending on how you bucket them, that impact business value that business owners can pull to impact their business value. You can use those levers and business value as a north star for your business. Most business owners have a purpose, and they have a mission. They’ve got that driving force. Business value can be seen as kind of a measure of how well you’re executing on that mission, that drive – generally your business value increases when you’re working on the right things and those seven or eight levers typically are what I would call kind of a win-win. I do a lot of volume-earning studies. In that process, we spend a lot of time talking about the quality and integrity of financial data and business data in general. Quality of data is a big driver in the value of a business. When I talk to business owners that are thinking about selling their business, one of the things that I bring up is talking about the quality of their data. We talk about how a buyer might see their data, how they see their data. We might talk about some of those gaps in perception data, things that they do to mediate those gaps. I would say nine times out of ten, by the time we end one of those discussions, talking about the quality of financial data, the business owner is walking away from that conversation saying, “Whether I choose to sell or not in five years, doing some of these measures, it’s just good business. It’s going to help me run my business. It’s going to make my life easier. It’s going to de-risk what is oftentimes one of the biggest assets in my portfolio.” It's a win-win in the sense that you can strategically align these levers or weave these levers into your business strategy and, whether or not you want to sell, you’re going to be in a better position long term. Bryan Powrozek: It’s one of the largest investments in most business owners’ portfolio. So why would you look at it and treat it any different than any stock or bond or mutual fund that you have? You know that you got to sit there and look at it on a periodic basis and say, “Hey, am I getting the return out of this that I would expect?” The only way to really measure that return is looking at the value and has the value grown over time the way I would expect it to. To touch on something you mentioned Ben, that a lot of these decisions are just good business sense, right? Like an example of that would be say customer concentrations, right? Everyone knows that you don’t want all of your eggs in one basket. Can you walk through how that would be viewed from a valuation perspective and, therefore, why it’s important and it makes good business decision? Bryan Smith: When we talk about business risk, kind of going back to what Jane was mentioning earlier, buyers are buying future cash flow and, if your future cash flow is heavily dependent on a single customer versus 10 or 15 different customers, there’s a bigger chance that that customer might be unhappy, not like the new buyer or what have you and walk out the door. There’s just less risk in general when you’ve got that revenue or that cashflow diversified amongst a larger client base. There’s less risk or a chance that they’re all going to get up and walk away. Bryan Powrozek: I equate it to buying or selling a house. Because you go in, you agree to the purchase price. Then you get your inspection and then you haggle over. Is the roof too old? Then it’s going to have to be replaced soon or is the air conditioner going to go out and, therefore, I need to reduce the value of what my offer is? Jane, from your experience, what are some other areas that impact the value that owners might not necessarily be thinking about? Jane Tereba: I would dovetail off what Ben said about that quality of earnings and the quality of financial data. That is so important. The first thing that we do when we do business valuation with an owner is we will get five years of financial statements, historical financial statements, income statements and balance sheets. We look at the company’s operating expense structure. And when there are fluctuations and expenses, some things are classified one way one year and classified it one way a different year, and it’s explainable but it’s showing some fluctuations that you wouldn’t necessarily expect. Not that that’s going to cause questions, but it might. And the more consistent that you can make your accounting – the more you can work with an outside accountant to either do a compilation or a view engagement for you to lend to credibility those financial statements, the better because again, I’m going to go back to what I said before and what everybody else is kind of echoing is that it’s cash flow and risk. If we can’t rely on the historical cash flows, it’s going to call into question whether we can trust the future cash flow. That’s one of the things that we will look for – and the buyer would look for -- is how reliable is the forecast that’s being developed. That’s one of the risks that we would look at to say, “Hey, business owner, if you want to work on your business and increasing the value, clean up that accounting.” So, there’s more credibility in your ability to forecast and make sure that the accounting is smooth and is consistent. Ben also mentioned another one that we always look at -- switching to the risk side. Being able to look for ways that you can decrease the risk within your business. Most of that cash flow is dependent on one customer. That increases the risk to a buyer because if there’s something that goes south with that relationship, then the eggs are gone. I’m sure you all know there are ways that you can mitigate that if you’re able to put in contracts in place. Sometimes we’ve seen where there are large relationships with customers but they’re with different departments. Sometimes that helps to mitigate where you don’t necessarily just have one person you’re working with. There might be some ways to diversify the relationship and, certainly when we’re looking at it from a value perspective, we’re looking also at how long has this customer been a client? Is it somebody that’s known to be fickle, like a Walmart, or is it somebody that you’ve been with? Switching gears back to the cash flow and risk, focusing on the cash flow is one of the things that you can do to manage proactively your business value. The most impactful way to increase your cash flows if you’re able to is really focusing on the efficiencies of that gross profit line and that revenue less direct cost. The more you can do to increase the efficiency of the jobs that you’re performing, the more impact you will have on growing the company’s value. I just spent some time with a client a couple of weeks ago and, they have such a unique value proposition. I was trying to figure out where it was in the cash flows, and they went right to the operating expenses and said, “Oh, well we could probably save a few thousand dollars on our telephone expense if we did such and such or we could …” So, they go right to looking at those operating expenses. While those are important -- to make sure that they’re consistently reported -- making the tweaks to those isn’t necessarily going to be as impactful as trying to increase sales and increase the gross profit margin or the direct – the revenues less the direct expenses. It can be helpful, but people tend to take too much time really refining those operating expenses when the true bang for your buck comes up a little bit higher. One of the other risks that we often see, as well as the customer concentration that we talked about, is how reliable is the forecast that you’re relying on for the business value, customer concentration certainly. Vendor dependence is another one that we look at. Those are the ones that tend to be commonly present in most companies that we value. The other one is dependence on key management members. It’s unavoidable when you’re owning and managing a small, privately held company. But the more you can do to really develop that next level of management team, the more the risk gets diversified away from who are the owners, right? So, the risk to the buyer is that owner leaves and now nobody knows what to do because they’re gone. So really having a nice solid management team and potentially having employment agreements with them that secures that – you know, that reduces that risk to a buyer knowing that these people who are so well-educated in what the company does are likely to stay. That would be one way also to diversify some risk is really to focus on the key management team and delegate, not just in words, but delegate to the team because we’ve seen that too where people say they have this team, but they still do everything themselves. Bryan Powrozek: I think we’ve all seen and worked with the businesses where everything is in the business owner’s head. They really are the company. Yeah, they’ve got staff around them that get the day-to-day work done. But when it comes to the real engineering and the business development and all that, it all resides with the owner. Jane Tereba: Exactly, exactly, yeah. Bryan Powrozek: One thing we run into a lot with privately held businesses is the owner doesn’t draw a salary. They just take distributions at the end of the year. So, when you look at their income statement, they’re very profitable. But then the buyer is going to come in and look at that and say, “Well, where is your management compensation? We need to adjust that down.” Sometimes that’s a little bit of a bitter pill for people to swallow. Are there any other things like that that you guys have seen where there may be a very good business reason why the owner is running things the way they’re doing it. But not thinking about it, they could put themselves in a position where they can be subject to a discount. Jane Tereba: There are two other places where we see it commonly. One is if you are renting. The operating entity doesn’t own the space that you are in. You got a related party that owns the property and that rents between the operating company and the real estate company are set – however usually tax motivated, it’s set. Not necessarily market driven. That’s another adjustment where we will commonly make an adjustment for what is actual market rent based on the rates, the going rates in the community. The other thing that we sometimes see is tax planning. So many companies are trying to accelerate expenses. They accelerate deductions such that they’re minimizing their tax liability. So sometimes that can be – you know, they will come and say, “Oh, and by the way, we have all these things that we did because we’re managing our bottom line,” and the buyer is thinking this is not really reliable again. So again, back to the cleaning it up. Brian Powrozek: It’s balancing those two, right? Because there’s something that may make sense from a tax planning perspective. Jane Tereba: Absolutely. Bryan Powrozek: When we were prepping for the podcast, you shared an example of a businessowner that you met with who was walking in with this value in their head that oh, my business is at least worth this. And then once you get through this process, it’s like wow, it’s a fraction of what I thought it was going to be. Jane Tereba: Yeah. That one will haunt me, and it was because they got some guidance from their accountants saying that their business, which was a transportation company, so very heavy, asset-intensive company, that the right way to value that company was to take a multiple of revenue, one times revenue. He thought it was going to be worth something like $12 million to $13 million. Ended up being worth half that when you looked at what the cash flow – what that fleet could generate, what cash flow was available to owners. You know, we also in that situation looked at the liquidation value of the assets. Those shortcuts and rules of thumb are dangerous. Making sure you get in there and really do the work to understand how the business operates, how it’s going to generate that return to get a good sense for what the value is. Bryan Powrozek: What are your views on just doing that kind of back-of-the-napkin valuations for business owners? Clint Bundy: Before we even are fully engaged by a client, we like to give them a preliminary valuation analysis. It’s going to go through probably a lot of the same mechanics that Jane would – depending on the company but a lot of times it’s getting to some kind of adjusted EBITDA (earnings before interest tax, depreciation, amortization) figure. I use the term “adjusted” because there could be nonrecurring expenses, extraordinary expenses, and other related expenses. It could be added back or sometimes they must extract it out to get to the right adjusted EBITDA. And in some cases, we can talk about valuation based off the revenue, recurring revenue or hybrid thereof. But from a process perspective, we like to do a preliminary valuation assessment. And our valuation is going to be heavily centered on what we know the market is trading at today. Being a specialist in the automation segment where we know what buyers are willing to pay. We can divide it out between fair market value and premium value so that we can explain to owners, “Look, here’s kind of market fair and then here’s premium value.” And a lot of times, of course, we are saying, “Here’s 150 yards down the fairway using golf analogy. You can get on your own maybe or with not a lot of competition and then here’s going in that extra 150 yards down the fairway to get to premium value.” And so ultimately final valuation is not determined until you run the competitive process and push buyers to pay maximum value. Jane Tereba: The problem we have with multiples is exactly – it’s exactly what Clint says. We usually will tell clients something very similar but use the words, “value doesn’t always equal price.” So I can come up and tell you the fair market value of your company is X. And just like you were going to sell your house, you listed it at say $500,000, but you’re in a great neighborhood with great schools and there’s a housing boom so somebody will pay you $600,000, site unseen, and no inspection, and no whatever. Motivation of buyer and seller is so important, and the psychology of the deals are very important. The problem with multiples is that you don’t know what the psychology of the deal was. You don’t know if terms were given, if cash was paid up front, what was negotiated. Was there a non-compete agreement? Was there an employment agreement? Was there an earn out? There are so many terms of the deal -- how the deal got structured -- that can impact the price. And the price is what drives the multiples. That’s our warning against multiples. It’s a good way to get yourself a ballpark, but if you really are serious about understanding the business value, you have to go into the process. Bryan Powrozek We’ve hit on a few things here, which fall into those general umbrellas that Jane talked about initially -- the risks and the cash flow. From a risks standpoint, you got your concentrations of customers, even your concentration of vendors if you’re very dependent on a particular technology, as we’ve seen with supply chain issues here. But then when you start talking about cash flow, now you’re getting into some of more maybe the financial reporting type things. Ben, to bring it back over to you, what are some of the ways that you’ve seen business owners tried to monitor this within their business? Ben Smith: It starts with talking to Clint, talking to Jane, understanding what those aspects of your business are or the areas of opportunity are in your business to drive value. And once you have identified those, you can monitor them in a few different ways. What I’m seeing become a little bit more probably popular now is people using technology -- using dashboards and real-time data to start tracking some of these things that we talked about today. Dashboard and technology might be something that folks looked at 5, 6 years ago and say, “Hey, it’s not a fit for us. It costs too much. It’s too much to implement.” That dynamic has changed a little bit. Those costs have come down, there are some great tools out there to help segment and look at data on a real-time basis and watch what’s happening in the business and measure more importantly how well initiatives are working. Outside of that, it’s just important to measure in general. Start getting a management reporting package together. Look at it monthly, look at it on a quarterly basis, look at it on an annual basis, and look at it from what are my recurring customers, what’s my software revenue, what are my revenue streams, what are my costs, that type of thing. And that can be something that your CFO, your financial controller can start putting together for you. I see single owners say, “I’ve got a pretty good sense of my business and where it’s at, so I don’t necessarily need all of that management reporting that you’re talking about.” But I’ll tell you that once you talk to Clint, once you talk to Jane, you’ll understand that business owners look at your business and your data potentially much differently than you do. And it’s a great idea as a single owner to take a step back on a quarterly basis and look at the story that your data is telling you. Brian Powrozek: Well, one area that has been underlying in everything else we talked about is forecasting and your ability to hit those forecasts. And I know most every business probably at least goes through an annual budgeting process. And then that budget goes on a shelf for 12 months, and then you dust it back off. But I know you advocate for making that part of your process because that’s something that buyers are going to look at and say, “How well can you forecast this? Because if you are coming and telling me that you’re going to grow by 10% next year, prove it to me. You had a history of being able to forecast and then match your forecast.” So that comes into play as well, right? Ben Smith: Yeah, absolutely. And if you are listening today and you don’t have a budget, I’ll say that you’re not alone. But that’s a huge area that people can focus on to drive value. Once you start trying to budget, you understand what you need to work out, and you get a better sense for how to do it a little bit more efficiently. It’s never going to be a 100% accurate. But the better you are at demonstrating that you have a handle on your business, and you have a handle on hitting historic budgets, that just increases the buyer’s confidence in your knowledge of what’s going to happen to your business in the future. Bryan Powrozek: Being overly conservative in budgets can be just as impactful, right? That hey, we always over budget for this and we come in under, so we end up being more profitable. But from a buyer’s perspective, it’s like, “Did you not understand what’s going on in your business, and you just got lucky or if not, why were you over budgeting for that because now that’s capital that could have been deployed somewhere else, et cetera?” Ben Smith: I see that as well and I would say that to a degree, engineers and CPAs are in the same realm and that they might be a little bit more risk-averse so it’s like, “I don’t want to throw anything out there that I can’t hit.” While I don’t disagree with that being overly conservative for the sake of being conservative also isn’t the right answer too. Bryan Powrozek: The underlying theme of this whole conversation is really to critically look at how your business is going to look at a sale. And then focus on those areas that the potential buyers are going to focus on and really try and tighten up your practices, your policies, all sorts of things like that so that when it gets to that point “Yeah, maybe I’m not looking to sell in the next 5 years but it doesn’t mean I shouldn’t starting to act like I might be ready for sale in 5 years.” Clint, let’s go to the other side of the spectrum. The person that gets that phone call tomorrow saying, “I want to buy your business,” and didn’t have time to put any of these things in place to get themselves ready for sale. What advice do you have for the owner that fields that call? Clint Bundy: Owners today are getting phone calls from buyers on an unsolicited basis. That is just happening. And they are getting them multiple times a week. And for an owner, that creates a decision point. Do I go down this path and talk to this one buyer and see where that leads. Or option 2 is just, I don’t do anything, I ignore it and just keep doing what I’m doing. Or option 3 is maybe I should find out the real value of this business and create a market value and maybe bring on a Bundy Group to run it or bring on a Clayton & McKervey to do a sales or quality of earnings report. And every owner of course must make their own decision. I will tell you that a lot of owners think, “Well, if I go down the unsolicited route where I just take the one call, I’m saving time and energy and can hopefully get my number that I want.” Most owners who had gone down the unsolicited route, at the end of the day, they ended up spending just as much time and energy and expense going the unsolicited route as they would have had they gone, “Well, let’s go to market and test the market,” route. They just spent that time and money in different ways on the unsolicited route. And frankly, can increase their stress because they haven’t done the prep. What they’ve done instead is jump ahead and jump in the designing of the ROI phase, which then gives the buyer all the advantage. The buyer comes with their transaction accounting team and tries to make use of limited information to squeeze the owner on pricing value. We think an owner maximizes value and reduces stress by doing the three phases that I articulated earlier. And if they are doing it the right way, maximizing value. Ben Smith: I’ve seen kind of both types of processes happen and there’s no free lunch. If you think about corporate developers, they’re out there looking for a person that’s not prepared and knocking on those doors for a reason because there’s better value for them. So, Clint is spot on with his advice there. Bryan Powrozek: I’m going to give each of the panelists a chance to give their last piece of advice. Jane, I’ll let you lead it off. Jane Tereba: It’s so important for us as business owners to just stop for a minute working in our business and work on our business. So, all of the different things that we talked about with the different risk levers and everything, culture and customer relationships and management diversification, and all of those different kinds of risk factors that we talked about, reducing those risks, even if you’re not heading imminently into a transaction, will create a better culture, create a star in your company. And so, the more time that you can be disciplined to work on your business, and you set the right amount of time if that’s once a month, a quarter, 6 months, hopefully not just once a year. So take some time and really devote to what can I do to increase – come at it from a business value perspective but even as like I said, you’re not heading imminently into a transaction, it can be so important just in being able to attract employees, retain employees, customer relationships, people that love to come to work. Bryan Powrozek: Clint, your final thoughts? Clint Bundy: Whether they are thinking about a sale or recapitalization down the road or not, always be thinking about building value, building the company in the right way using a lot of the key fundamentals we talked about today. And I would encourage business owners to use experts active in the automation space as a sounding board. Bryan Powrozek: Ben, you’re going next. Ben Smith: Working on business values is a win-win. It doesn’t have to be an organization thinking about an exit. We are doing these things because it would be better for it. So, there’s a different light. You don’t have to break confidentiality. 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