With the right long-term execution, you can end up with a valuation more than three times the industry average. It just happened to a company in Milwaukee.
When most business owners think about boosting their company’s valuation they think of growth as the key driver. The theory behind that approach is that if you grow the top line, that will boost overall earnings and earnings before interest, taxes, depreciation and amortization (EBITDA). The higher EBITDA multiplied by the prevailing industry multiple will determine the price an investor will pay for the business. It’s a linear relationship between growth and value.
The other key driver these business owners will focus on is the margin. Get lean around your cost structure and drive the best possible margin. That too will boost EBITDA and thus, the value of the firm. The smartest of these business owners also have international sales.
They’ve recognized that the data is crystal clear. Exporters grow faster and enjoy higher margins than their non-exporting peers. (Exporting can have an even more powerful impact on valuation as we’ll show in a subsequent article.)
However, thinking of valuation as a linear function overlooks a great leverage opportunity. The truth is, there are things you can do or stop doing that will impact the multiple. Raising the multiple by even one point can have a significant impact on wealth creation for a business owner.
Investors have a forward view. They have two basic questions – will existing revenues be sustained, and what are the opportunities for growth.
The smart money knows that the highest performing companies get more than 90 percent of their innovations from employees. Being innovative is key. This is becoming a hard reality in every industry. As we enter what’s being called the fourth industrial revolution, things will be changing even faster. Research shows the high-performing companies are innovative and implement a high proportion of their employees’ ideas.
Innovation represents a change in direction. It can mean a small change in direction – e.g. a process redesign; or a large change in direction – such as diversifying into a new product line, acquiring a new customer base, or going international.
To get the best ideas, the way you manage people matters most. A management structure that eliminates the risk of bringing forward ideas and has an appetite for failure is critical. This means implementing structures that drive responsibility, authority, and autonomy down to every employee. Having diversity in your employee population is also important because diverse people bring different thinking to the table.
You can demonstrate an innovative culture by tracking average ideas per employee, the proportion of ideas that are implemented, and employee turnover. Employees will stay with a firm where their thinking is welcomed. It takes time to build an innovation track record, which is part of the reason a valuation strategy is a long-term strategy.
Also important is having a track record of revenue diversification and a plan for future diversification. Diversification can be customer diversification, product/service diversification, or market diversification. For example, a very clear impact on the multiple can be seen in market diversification when a company goes international. By selling into multiple economies, revenues no longer follow the ups and downs of the U.S. economy. This is evident in the significant difference in growth rates between exporters and non-exporters during U.S. recessions. In our most recent recession period (2005-09), local-only companies that survived shrank an average of 7 percent while exporters grew 37 percent. That’s an impressive difference for investors. Exporters will have more predictable and sustainable revenues and will receive a higher multiple as a result.
Owner prerogatives: On the negative side there at two things you might consider not doing. First is hiring family members. Having family members in the business can be quicksand for investors. They will worry about family members who’ve been taking advantage of their special relationship with the owner and poison the well for other workers. Or they will worry about a family member who is a top contributor changing behavior when ownership changes. Or concerns are raised about key family members exiting the business soon after the transaction, creating a big hole to fill. The best strategy is find your family members something else to do long before you’re ready to exit, otherwise they can drag down the multiple.
Second, when you run the business for your personal benefit, doing things you would not be able to do were you not the owner, you worry the investor who thinks you are making decisions that don’t put the business first. It’s better to run the business the way a professional CEO would.
It is also important that your role as owner is no longer critical to the success of the business. By the time you’re ready to exit, the business should run well without you.
Several other factors can impact the value of the firm. Come hear more about these and how a Milwaukee company reaped a valuation three times the industry average on April 21st when BizTimes Media presents its M&A Forum. Then sit down with the experts for discussions on the strategy for growing the valuation of your company. Register at www.biztimes.com/maforum.
Bill Burnett is the director of export services for the Milwaukee 7. He can be reached at (414) 287-4118 or via email at bburnett@mke7.com.
