Chamber Insider Blog

It’s Never Too Soon to Think About the End

By Jay Gruendl of Corporate Results, Inc.

There are very few instances in business where someone will say, “It’s too soon to start thinking about that,” and this definitely applies to having an exit strategy.  While many of the financial metrics used in the initial valuation of the business can be maximized in the 18-24 month span leading up to a sale, there are deeper structural factors that need to be considered long before that.  Owners should give careful consideration to issues such as their day-to-day company involvement, the company’s offering, and the types of contracts being pursued.

At start-ups, owners are often the head chef, cook and bottle washer, however, if their exit strategy is to sell the business then the long term goal is to extract themselves from the day-to-day running of the company.  It is assumed that an owner sells to retire or pursue other interests; however, if the owner is the key to all of the customer relationships and the running of the business, then it is an increased risk to the buyer.  This could result in either a lower price or an earn-out where part of the sale price is based on the business achieving certain future financial goals.  The earn out ties the owner to the company when they may be looking to leave and it requires them to hit revenue and profitability targets after the buyer has taken control and imposed their own processes and procedures.  The owner who successfully implements quality managers to run the business and provides them with incentives such as cash payouts to remain through the transition can greatly reduce the likelihood of an earn-out.

When looking to attract possible buyers, a company will also want to be known for a specific offering.
Keep in mind that buyers usually have one of three goals:

1) acquire depth in a certain area
2) add a skill set they need
3) break into an agency or command.

A specific offering could be expertise in a skill set such as system engineering or it could be expertise in a technology such as cloud computing.  Other successful companies do not necessarily have expertise in a skill or technology, but rather a reputation for deep ties and knowledge of a specific agency.  A company with one of these offerings (expertise in a skill, technology or agency) will attract more buyers and a better price than a company with contracts for a miscellaneous assortment of work spread across multiple agencies.

A final long lead factor to consider is the company’s portfolio of contracts.  A common story we hear is owners surprised by their company’s low sale value due to the number of set asides in their portfolio of contracts.  Contracts set aside for small business, 8(a)s, SDVOSB, etc. have a greater risk regarding novation (government concurrence to transfer a contract from one company to another company).  Depending on the type of sale and the type of set aside, the Contracting Officer or SBA may not novate the contract.  Even if all set asides are successfully novatated, the buyer is usually ineligible to bid on the re-compete because they are too big, not an 8(a), etc.  That means these contracts offer little long term strategic value to the buyer other than a finite revenue stream.

A company can also be seen as high risk if a significant portion of their revenue is tied to a single contract.  An adverse development on that contract such as termination can wipe out most or all of the company’s value.  However, there is one exception we have seen on occasion and that’s where a small business has a crown jewel contract that the buyer wants.  In those instances, that one contract may be the sole reason for the acquisition and the sole determination of the sale price.

The factors above are not the sole determination of value, there are many factors that influence value.  What makes these factors so important is the frequency in which they have impacted a sale.  The fact that they are long term, structural issues means they are best addressed long before an owner begins to seriously consider selling the business.


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