What Lies Beneath

Where is your company’s value lurking?

In combination with mapping the value of the entity or benchmarking, an owner must ascertain other aspects of the business that differentiate it from the pool of existing industry participants.

A professional business valuation, conducted by an objective expert, is the vehicle that identifies where a company’s underlying intangible value is lurking to help sellers increase shareholder wealth, as well as obtain a better deal price and identify strategic buyers.

In some cases, the intangible value of the business is far more valuable than the actual tangible value of the business. There are two ‘types’ of intangibles: Blue Sky and Goodwill. Blue Sky is the difference between the reported book value of the business and the asking price for the business. Goodwill is the remaining difference in the value of the company, as determined by a professional valuator, after all intangible and tangible assets are quantified.

For acquisition purposes, intangible value means the difference between:

• An attractive, lucrative investment and a profit for the seller; and
• An asset purchase and a breakeven or loss for the seller.

A strategic plan, which includes regular business valuations, is key if the owner ever hopes to receive desired shareholder wealth or a desirable price upon the sale of his or her business. An owner must develop a plan, execute that plan, monitor the results achieved and continually modify the plan. Not only does a business owner need to gauge the health of the business on a regular basis, the owner must also monitor the business’s attractiveness with each strategic step toward the planned exit and enhance that attractiveness to prospective outside buyers whenever possible.

From a business valuator’s perspective, there are certain intangible value drivers that make a company more valuable, and these drivers make the company a more atractive investment from a buyer’s perspective. Owners must also examine the anti-drivers, or those factors that decrease the investment value. Intangible value varies not only by company, but by industry as well.

The construction contracting industry. Contractors may be largely comprised of asset value; however, for all contractors, and especially those who do not have a substantial balance sheet (electricians, plumbers, etc.), intangible value is seen in these drivers.

• Bidding process: Is the company invited to bid? Invitations indicate community and industry goodwill.
• Bonding: Does the company qualify for sufficient bonding? Is the company required to be bonded for the contract service provided? As a bonded contractor, does the company gain contracts competitors may not?
• Clientele and diversity: Who is it comprised of (government, commercial, residential) and is it transferable? A diverse base enhances intangible value.
• Contracts and billing: The value of signed contracts to be completed and how a company bills work in progress is important. Do signed contracts exist and are they transferable to an unrelated new owner?
• Working capital: Many construction companies can be difficult to replicate due to the amount of working capital required to fund long-term projects. Maintaining sufficient working capital is critical to funding existing projects and gaining new contracts. Many construction contractors fail from lack of working capital despite showing profitability.
• Marketing and new sales techniques: How is new business generated?
• Diversity and nature of specific contracting service: Do the services offered allow for repeat business?
• Experience of management and personnel: Are managers and personnel certified?
• EEOC and workers’ compensation claims: Has the company experienced any significant litigious claims/issues?
• Longevity in industry: The business’s history is important. How long has the company operated in the industry, and is the name well-respected and recognized in the community as well? Those companies that are established with many years of operation are typically more marketable than those that are less rooted in the community.
• Union affiliated: In some regions and circumstances, union affiliation drives value down.

The retail industry. In many ways this industry is similar to wholesalers; however, retailers have a higher dependence on the immediate community and clientele base. In addition to many of the intangible value drivers of wholesale businesses, retailers must focus on improving these drivers.

• Accessibility, convenience and aesthetics of retail location: The location must be easily accessible, conveniently located and aesthetically pleasing (clean, organized, well-maintained) to visit. Along those same lines are sales per square foot and sales per employee, which are two very important benchmarks for a retail operation.
• Pricing and inventory: For retail operations, the amount of inventory can be substantial. Keeping inventory current and free from obsolescence is important.
• Branding and recognition: This coincides with marketing and clientele. Name recognition within a local community is essential to viability. The name must be associated with the customer needs.
• Marketing, advertising and sales techniques: How effective are current marketing and advertising techniques at attracting new customers? How do these techniques compare to local competitors? How often are new techniques employed?
• Repeat clientele: Repeat clientele are essential value drivers for the companies within the retail industry, and a high volume of referred clientele signals efficient operations management and a core position within the community and industry at large.

The manufacturing industry. Many small, closely-held job shops have slim margins and high costs. Therefore, the company must be seen not only as an investment vehicle but one that can provide a living wage for a buyer. Owners desiring to sell their manufacturing company should consider growing the business’s intangible value so that a future acquisition (synergistic or otherwise) significantly exceeds the value of the machinery and equipment.

• Machinery and intellectual property: Does the company stay abreast of technological trends, and is it able to maintain those trends? Manufacturing facilities should maintain technologically advanced machinery. The age of equipment is also important. Moreover, trademarks, patents and intellectual properties are all intangibles that increase the value of a manufacturing operation.
• Growth: Growth or improvements must be consistent for several years (preferably three or more), not just one or two.
• Bad debts and uncollected, lost accounts: This is a significant problem with job shops. Does this exist and if so, how are these issues overcome so that the expense rarely occurs?
• Certification: Is the company ISO certified (preferred) or ISO compliant?
• Clientele and diversity: Who is it comprised of (government, commercial), and is it transferable? A diverse revenue base enhances intangible value, whereas a concentration of clientele increases risk. Again, client concentration increases business risk. Be leery of maintaining equipment specific to any one particular client.
• Competition: If applicable, how does the company overcome competition from foreign (overseas) manufacturers who have substantially less production costs and expenses?
• Contracts: Do they exist, and are they transferable to an unrelated new owner?
• Employee benefits: If benefits are offered, is the company able to maintain the expense?
• Employee costs and retention: High labor costs in the United States, relative to foreign labor costs, have affected the manufacturing sector. What is the turnover rate, and how does the company retain productive, experienced employees?
• EPA, EEOC and workers’ compensation claims: Has the company experienced any significant litigious claims/issues?
• Experience of management and personnel: Is management and personnel certified and/or are they experienced journeymen? Buyers want to know who and how many have technical skills.
• Job costing: Does management track the cost of productivity per employee and per machine to assess profits and future growth?
• Marketing and new sales techniques: How is new business generated, and how are existing clients retained?
• Union affiliated: Again, union affiliation can drive a company’s value down.
• Working capital: Does the company maintain a sufficient ratio of sales to working capital? Steep working capital requirements create barriers to entry. Sufficient working capital is imperative for a manufacturing operation, as it implies effective operations management and an adequate turnover of receivables and inventory.

The transportation/trucking Industry. Companies within the transportation and trucking industry can be classified as either contract or service related. Typically the capital assets are held within the company itself and therefore the majority of ownership value tends to be derived from the balance sheet. To achieve a value above the fair market value (or market value) of the assets, an owner must enhance the goodwill of the company by examining those intangible value drivers listed for service entities and contractors. Trucking companies may be acquired by existing competitors to expand regional markets. However, in many cases, anti-drivers (listed as follows) hurt the investment value of a trucking enterprise.

• Cargo and freight: Does the company transport hazardous materials or freight? If not properly managed, this type of transport service could be a detriment to the company as fines and litigious matters could consume the company’s goodwill.
• Customer relationships and revenue growth: Routes and solid customer relationships contribute significantly to a transportation company’s bottom line. Also, what is the annual revenue mileage per vehicle?
• Employee retention: Long-haul truck drivers vs. short-haul, sleeper cabs versus day cabs; although the ranks of long-haul drivers expanded almost two percent over the past two years, short-haul drivers typically have a lower percentage of employee turnover. What employee retention tools does the company have in place to retain experienced and low risk drivers?
• Citations, fines, penalties, extraordinary property damage: How effective is management at controlling and reducing these types of expenses, including insurance costs (and claims) and property damage (cargo or personal). Citations and fines many times become a matter of permanent and public record.
• Licensing, permit, and the upkeep of maintenance: How effective is management at maintaining licenses, permits and tractor upkeep and maintenance records? Losing control or poor management of these areas will not only financially devastate a company but are many times a matter of permanent record if violated.
• Regional vs. multi-regional versus international: Does the company operate in multiple states or cross country borders (Mexico and Canada)? If so, how effective is management at maintaining multi-regional licenses, permits and international requirements?

The wholesale industry. Many entities within this industry are acquired to expand product diversity and regional market areas. Typically, closely-held wholesale entities have slim profit margins; therefore, to attract outside buyers, the intangible value must be enhanced and maintained. As with the other industries, the intangible value drivers for wholesalers are dependent on a basic set of factors.

• Clientele, repeat clientele and diversity: Who is it comprised of (government, commercial, residential), and is it transferable? Repeat clientele are essential value drivers, and a high volume of referred clientele signals efficient operations management and a core position within the community and industry at large. A diverse base enhances intangible value.
• Competition: Are products priced competitively? How does the company offer competitive prices and still maintain high-quality, timely wholesale services?
• Contracts: Do they exist, and are they transferable to an unrelated new owner?
• Diversity of products, inventory and pricing: A diverse product base alleviates dependence on a product, for example, with profits dependent on the health of the economy (regional or national) or industry trends and existing technology. Inventory should be current or free from obsolescence. In addition to the size of the operation, the quantity and quality of product lines is important. Pricing and purchases should focus on achieving a gross profit margin of 25 percent or more.
• EPA, EEOC and workers’ compensation claims: Has the company experienced any significant litigious claims/issues?
• Operations and facilities: Maintain adequate logistical distribution channels, good supplier pricing and terms with adequate facility size and location.
• Marketing and sales techniques: How are new contracts generated, and how are existing contracts renewed? Does the company also market via a well- constructed Web site to capture the everincreasing Internet sales business?
• Method of delivery: How are products delivered and shipped, and how effective is management at overseeing the efficiency and cost-effectiveness?
• Union affiliated: In some regions and industry sub-categories, union affiliation drives value down.
• Working capital: Does the company maintain a sufficient ratio of sales to working capital? Sufficient working capital implies effective operations management and an adequate turnover of receivables and inventory. Inventory must also be maintained at levels of profitability and consumer/ seasonal demand.

A business has intangible value drivers and anti-drivers, respectively, which make a company more valuable or decrease its value. Additionally, a company’s intangible value and goodwill are also directly correlated to the particular industry in which the company operates. Utilizing business valuation, owners must monitor the business’s attractiveness with each strategic step toward their planned goals. Overall, owners must recognize where their company’s underlying intangible value is lurking to maximize shareholder wealth, as well as maximize sell price.