M&A Basics: Building a Sellable Business

To unlock the utmost potential of your business, it becomes paramount to comprehend the desires of prospective business buyers—and then transform those aspirations into reality.

A thriving business often calls for more than just a solo act; buyers are drawn towards well-established infrastructures and capable management teams.

The journey from birthing a business to nurturing its growth demands a distinct skill set. Each phase of growth necessitates a unique array of talents.

The abilities that pave the way to achieving a $1 million revenue stream differ from those propelling a business to the realms of $10 million or $100 million. Regrettably, many entrepreneurs find themselves stuck in the initial stages of growth, hindered by their inability to “institutionalize” their enterprise. The art of institutionalization, however, is the pivotal force not only behind business expansion, but also in the enhancement of its intrinsic value.

Instituting your company entails the strategic implementation of systems. This practice achieves three pivotal goals:

1. It readies your company for the forthcoming phase of expansion.
2. It augments the overall value of your enterprise.
3. It enhances the marketability and appeal of your business.

Should your aspirations encompass extracting the maximum value from the sale of your business, it is imperative to instill institutionalization—enabling the business to operate seamlessly even in your absence. This enlightening article elucidates the steps toward achieving this remarkable feat.

Building a Sellable Business — Institutionalizing Your Business

Institutionalizing your business is a strategic endeavor achieved through the meticulous establishment of systems and the cultivation of an adept management team.

System Implementation

• The process of developing systems entails the refinement, automation, and comprehensive documentation of your operational workflows. The documentation of critical processes significantly enhances the viability of successfully selling your business.

Advantages of system implementation:

• Enhanced ability to attract and retain high-caliber employees, facilitated by well-defined processes and precise job descriptions.
• Simplified business management through comprehensive process documentation.
• Elevation of your company’s valuation.
• Augmentation of the likelihood of a successful business sale.
• Formation of an Effective Management Team

A notable portion of businesses generating revenue below ten million dollars typically lacks a formalized management team. The absence of proficient management may render your business vulnerable to decline in your absence. How resilient is your business to your potential absence? Could it endure for a year, a month, or merely seven days?

As you embark on the journey of establishing a professional management team, you will encounter a fresh realm of skills that often differ from your initial entrepreneurial skill set. While your initial business endeavors likely encompassed multifarious responsibilities undertaken by yourself, a juncture will arise where the cultivation of a cohesive team becomes imperative.

The construction of an effective team necessitates adeptness in recruitment and management. Proficiency in identifying and recruiting top-tier talent, as well as eliciting optimal performance from your team members, becomes paramount.

An essential preliminary step involves identifying the pivotal positions that would impart the greatest value to your enterprise. What are the core needs of your company? Could a CFO, COO, VP of Marketing, VP of Sales, VP of Human Resources, or an external president elevate your company’s trajectory? Dedicate ample time to the comprehensive development of a structured management team. This not only renders your business more marketable, but is also likely to catalyze an upsurge in both revenues and profits.

Building the Right (Sellable) Business for Your Buyer Type

Gain a comprehensive grasp of the diverse buyer categories and their specific demands for systems and management teams before embarking on the endeavor of establishing these elements. These buyer categories can be distilled into three broad types, each exhibiting distinct preferences concerning the infrastructure and systems integral to a business. As you ready your business for sale, it becomes paramount to fully comprehend these distinct buyer types, their evaluation criteria, and the optimal strategies to position your business for maximum appeal across these varying profiles.

Buyer Type #1 — Independent Purchasers

For businesses valued at less than five million dollars, the likely purchasers are individual buyers.

• The significance of elaborate infrastructure is relatively diminished in their perspective. This is due to the fact that most individual buyers anticipate direct involvement in day-to-day business operations. Should your business fall within the scope of individual buyer interest, an extensive investment in infrastructure prior to sale might not be imperative. However, it is imperative to ensure your business possesses sufficient infrastructure to facilitate a seamless transition. While this group of buyers requires a lesser degree of infrastructure compared to corporate or financial buyers, a foundational level remains crucial.
• A number-driven mindset characterizes these buyers. Prioritizing profitability over infrastructure construction holds sway until your EBITDA surpasses $1,000,000. In instances where the business valuation lies below $5,000,000, the allocation of resources is often better directed toward bolstering sales and marketing efforts to amplify revenue and profitability, rather than channeling significant resources into infrastructure development. Certainly, augmenting infrastructure proves advantageous. Nonetheless, individual buyers typically exhibit a predilection for heightened cash flow as opposed to heightened infrastructure.

Buyer Type #2 — Corporate Buyers

The extent to which corporate buyers necessitate infrastructure within your business hinges upon their strategic approach: whether they intend to seamlessly integrate your enterprise into their own or uphold it as an autonomous entity post-acquisition.

• Integration Approach: Corporate buyers aiming to integrate your company within their own operations generally demand a lesser degree of infrastructure within your business compared to scenarios where it is envisioned to function independently post-acquisition. In such instances, the acquirer already possesses an established framework, minimizing the imperative for your business to maintain an extensive infrastructure presence.
• Standalone Approach: On the other hand, corporate buyers opting to maintain your business as an independent entity necessitate a substantial infrastructure presence. The viability of your business as an attractive acquisition target often hinges on the sufficiency of its infrastructure. Prospective buyers of this nature are unlikely to proceed with the acquisition unless your company demonstrates a robust infrastructure capable of autonomous operation. Frequently, these buyers designate a corporate office manager for eventual promotion to the role of company president. Notwithstanding, a well-structured management team and established systems within your business remain pivotal to ensuring a seamless operational transition.

Buyer Type #3 — Financial Buyers

Financial buyers predominantly encompass private equity groups, a relatively modern asset class characterized by a diverse spectrum of criteria, distinct from the more uniform preferences of corporate buyers. Among private equity groups, a range of focal points exists: certain entities specialize in lower middle-market enterprises, typically characterized by less extensive infrastructure. Conversely, others seek self-sustained entities where both ownership and management endure over a span of years, alongside a pre-existing robust infrastructure.

• The infrastructure requisites of these buyers display variability. Augmenting infrastructure holds the potential to elevate the value of your company and streamline its marketability, irrespective of the buyer’s identity. Across the board, buyers exhibit a preference for businesses boasting a substantial infrastructure—a factor that, when held equal with other variables, invariably enhances desirability.
• Financial buyers harbor the anticipation of doubling their investment within a five-year timeframe, subsequently relaying the business to another financial buyer. This growth trajectory is frequently achievable solely through the establishment of systems and infrastructure, which entail financial outlay. In instances where your business lacks these foundational components, the buyer assumes the expenditure required to implement them. This capital outlay is subsequently offset against the overall purchase price, factoring into potential returns and the feasible purchase price. It’s customary to deduct a multiple (typically two to three times) of this investment when calculating the final purchase price deemed attainable for financial buyers.
• A common stipulation among private equity firms involves the retention of existing management to oversee business operations post-acquisition. Partners within these firms predominantly dedicate their efforts to acquisition, seldom engaging in hands-on management of their investments. This dynamic necessitates the persistence of current management or the enlistment of a new management team by the private equity entity. The sole exception to this paradigm emerges when the private equity firm already owns a portfolio company that directly competes with yours, aiming to integrate the two businesses.

Additional Factors that Determine if Your Business is Sellable

Subsequent to this are pivotal aspects that potential buyers scrutinize when evaluating your company as a potential acquisition. At times, these aspects demand precedence before delving into the construction of systems and a management team. A profound grasp of these decisive elements equally informs the strategic selection of systems to be enacted prior to presenting your business in the market.

Profitability

The foremost factor that captures the attention of potential buyers is profitability, often measured by EBITDA. A limited number of buyers will express interest in a company that isn’t generating more revenue than it’s expending. When your business isn’t yielding profits, it’s prudent to allocate resources towards sales and marketing endeavors instead of investing in building systems. It’s only when your business attains a state of profitability that consideration should be given to the development of infrastructure.

While many buyers may entertain the prospect of acquiring a profitable business with minimal infrastructure, a meager number would contemplate acquiring an unprofitable business despite its significant infrastructure. The fundamental principle of prioritizing profitability over infrastructure remains steadfast until your EBITDA reaches the commendable threshold of $1,000,000 annually.

Scalability

Discerning buyers seek enterprises with inherent scalability, poised for swift and substantial growth. Both financial and corporate buyers hold a strong affinity for businesses with untapped potential, wherein the owner’s efforts have not fully realized the business’s capabilities. This often pertains to scenarios where an owner is fatigued or where robust sales and marketing mechanisms have not been established. However, the presence of operational systems that enable rapid expansion post-amplified sales and marketing efforts is pivotal. To maximize the value of your business during a potential sale, a strategic focus on cultivating inherent scalability from the outset is of paramount importance.

Competitive Edge

Corporate and financial buyers actively seek out businesses with enduring and defensible competitive advantages, setting them apart from easily replicable offerings. In contrast, individual buyers tend to gravitate towards lifestyle businesses lacking such competitive edges.

While a less seasoned buyer might consider acquiring your company even in the absence of a competitive edge, many astute buyers would hesitate. It’s crucial to understand that exceptional customer service or personal relationships, while valuable, do not inherently confer a competitive advantage.

For your business to entice discerning buyers, it necessitates a distinctive competitive differentiation that defies facile replication. This imperative underscores the challenge of selling your business to anyone beyond a less sophisticated buyer. Keep in mind, a noteworthy observation is that nearly every company valued above $5 million in selling price garners interest from sophisticated buyers.

Summary

Achieving results is a dynamic interplay between individuals and systems. In the realm of small businesses, crafting a capable management team often takes precedence as the linchpin for fostering a marketable enterprise. However, certain businesses find greater value in the establishment of robust systems. In essence, there exists no one-size-fits-all solution.

Contemplate your business as a prized asset right from the outset. Delve into strategic considerations for the eventual sale of your company. Channel your energies into cultivating a profitable, expansible enterprise fortified by an insurmountable competitive edge. The key lies in enlisting adept individuals and erecting meticulous systems. The outcome is twofold: a considerable surge in your company’s valuation and the potential for enhanced financial gains, all while elevating the quality of your personal and professional life.