November 2022 Volume 4

OPERATIONS & MANAGEMENT

Leadership and Management FAQ Answered By Joel Strom

This is the second edition of FIA’s Leadership and Management FAQ. I continue to encourage FIAmembers to submit questions that they would like answered in this FIA Leadership and Management FAQ column. FAQ 1 Let us start with a FAQ that I have heard from so many owners and managers of privately held manufacturing companies. How would a potential acquirer place a value on our company? There is a basic formula that most buyers will use to place a value on a manufacturing company they are considering for acquisition.That formula considers a company’s EBITDA (earnings before interest, taxes, depreciation, and amortization) sometimes referred to as free cash flow and a multiple of that EBITDA. The simple form of the equation is EBITDA x Multiple = Value. The EBITDA that is used in that equation is typically a weighted average of the last few years’ results with the latest year having a higher weighting. Some owners mistakenly believe that they should get a higher value because they just had a really good year. Having one good year is usually not enough. Buyers are more interested in a consistent trend. A weighted average of EBITDA provides more weight to the latest year but also provides a balance with the past few years. As shown in the formula, EBITDA is only one part of determining market value. Although obviously an important part, a company’s EBITDA is what it is. There is typically a limit to howmuch you can increase EBITDA without either pricing yourself out of the market or damaging operating abilities. However, what can dramatically raise the value of a company is increasing the multiple. The multiple reflects the years, assuming no change in EBITDA in the future, that it will take to recoup the price paid for the company. Many believe that a fair multiple in many situations is in the 4 to 6 range. That is; Weighted Average EBITDA x 4,5, or 6 = the price they should pay for a company. Yet I have seen companies sell for 10, 15, or even 20 times EBITDA. So, the key to truly increasing the value of a company is by getting the buyer to move the multiple they are willing to apply. Check out FAQ2 to see the obvious next question about moving the multiple. FAQ 2 This is everyone’s typical follow up FAQ in response to the answer to FAQ1. So how can our company move up the multiple that a potential buyer would be willing to pay?

This is a great question since it can have huge long-term positive consequences for the owners of a privately held company when they sell their company. The value a buyer puts on your company and the resulting multiple they are willing to apply is dependent on how badly that buyer wants or needs your company and the risk they perceive the purchase would create. The way to move the multiple that a buyer is willing to pay is therefore to increase their desire and reduce their perceived risk. The logical follow up question is: Ok, how can we do that? How can we increase their desire so that theymaximize the value they place on our company? One proven and highly effective way to accomplish this is by accelerating your company’s strategic value to create what I refer to as a “Gotta Have” company. A company that has moved from being ordinary to being extraordinary. A company that buyers would be willing to offer and pay the highest premium for. As a starter, you can gauge how close you are to becoming a “Gotta Have” by putting yourself in a buyer’s shoes. Ask yourself, would I pay a high premium for my own company? If you cannot say yes with conviction and with some basis, I doubt whether a potential buyer would say yes. Be honest with yourself and identify why you, as a buyer, would place a lower or higher multiple on a purchase offer for your own company. Becoming an extraordinary, “Gotta Have” company requires strength in every aspect of your company, from operations, to sales, products, services, and your team, as well as your financials. Strategic value and its four pillars (Financial, Strategic, Operational, Industry) is a concept that provides a methodology for establishing a roadmap to creating an extraordinary company. A company that is strong in all aspects of the four pillars. Unfortunately, there is not room here in the column to go into more of the details of strategic value. However, as a FIA Magazine reader, you have access to a simple assessment tool that can help you determine how close to “Gotta Have” status your company is. It will also help you identify where you need to focus your efforts to gain the greatest increases in strategic value and the resulting movement of the multiple. You can find and take that Strategic Value Assessment tool online with no cost or obligation, at www.chiefvalueofficers.com/ assessment.

Joel Strom is the Founder and CVO at Chief Value Officers. He has spent the last 4 decades accelerating manufacturing company value as an owner, CEO, and advisor. His recently published book, CEO to CVO, Moving Your Business from Ordinary to Extraordinary , has received excellent reviews and is available on Amazon. He can be reached at joel@ joelstrom.com.

FIA MAGAZINE | NOVEMBER 2022 48