For business owners and executives working toward an exit from their company, a CFO who is skilled in the entire lifecycle of a business transaction is invaluable. An experienced CFO will take the steps needed to increase the value of the company. By focusing on the drivers that increase value today, the business will become worth more to a buyer in the long-run. As a result, the owners will be able to exit with more profits than those who take a short term or last-minute approach.
The Role of a CFO
Many roads lead to the CFO position, such as financial reporting, tax compliance, and corporate governance. Among the senior leadership team, the CFO is uniquely positioned to contribute to the long-term value of the company because of the breadth of this previous experience.
Whether business owners are serial entrepreneurs or multi-generational proprietors building a 100-year legacy company, a CFO is crucial for creating value. Regardless of how long owners plan to hold the business, a CFO can make each potential long-term business outcome more successful by creating greater overall company value. Business owners and CFOs can work together to position the long-term strategy of the company and make the tactical moves necessary to maximize long-term value.
Increasing Business Value Strategically
Secure Recurring Revenue
While increasing overall profitability will certainly increase the value of the company, all revenue is not created equal.
Recurring and predictable revenue from guaranteed long-term contracts is the most important driver for businesses looking to increase value. Evidence that customers are “sticky” and have a propensity to repeat their purchases is another important value driver because it speaks to future brand strength.
A CFO can further increase value by allocating resources to business units and customer segments that generate recurring revenue. The CFO may also drive compensation incentives that foster recurring revenue streams.
Plan for Management Succession
Owner operators often are the business. Many business owners manage key customer and supplier relationships, drive product innovation, lead new customer acquisition, and act as the face of the company. As a result, it becomes impossible to separate the value of the business from the value of the owner. When the business is sold, the owner is not included in the transaction, and without a competent successor, the business immediately becomes less valuable.
Given adequate time and cooperation with the owner operator, a CFO can implement and support a management succession plan. The key is building a functional management team across all disciplines (operations, sales, marketing, human resources, and finance) that can function independently to get the owner out of the business. However, convincing the owner to give up control of the business is an emotional decision that can sometimes take years to accomplish, which is why it must be undertaken early in the planning process.
Professionalize the Business
Companies with an owner operator often employ financial management practices that are different from large private companies and public companies. Personal expenses are often co-mingled with legitimate business expenditures. Companies that are operated as the personal “piggy bank” of the owner might not be eligible for traditional bank funding without a personal guarantee by the owner, which hurts long-term value.
Furthermore, related party transactions, such as real estate leasebacks, are often used to shift income into or out of the company to distort its true profitability. Owner operators may also take shortcuts by opting for compiled financial statements instead of reviewed financial statements or a formal audit. As a result of these practices, financial statements may be unreliable.
Due to these legitimate concerns, a potential buyer may force the company to go through a quality of earnings exercise to validate the reported profitability. However, a CFO can professionalize the business by holding the business to a public company standard, where all transactions are treated as if they were arm’s length, with pricing based on the market.
Sell Underperforming Business Operations
Overall business results can be hindered by underperforming business operations, including pet projects. A strategic CFO can isolate the impact of unprofitable operations and then identify the most profitable course of action for the company, whether that be spinning them off or shutting them down.
Develop Long-Term Value Chain Partners
The most likely strategic buyers for a company come from the current ecosystem of the business. Customers, suppliers, and competitors will often pay a premium to enjoy the unique synergy that is generated by combining forces. Suppliers or customers may seek to purchase the business as part of a vertical integration strategy. Occasionally, competitors will become buyers as part of an industry roll up strategy. A CFO can aid in developing mutually beneficial long-term relationships to test the viability of a potential business combination.
Outsource Non-Core Competencies
The CFO can focus the business on whatever it does best – intellectual property development, low cost manufacturing, customer service – and outsource non-core competencies.
Reducing Business Risk
Owners do not always fully consider the negative effects of risk on the value of their businesses. However, focusing on risk as well as profit is necessary to increase long-term value.
Risk mitigation increases the worth of the business by driving value in the eye of the buyer. A CFO can increase value by identifying, quantifying, and mitigating the risk facing a business, such as:
Lack of Proper Financial Controls and Cash Controls
Division of duties, dual wire approvals, and daily wire limits are some of the controls that a CFO can oversee and implement to ensure that the business cannot be crippled by a rogue employee or external bad actor.
Uncovered Insurable Risks
Working with subject matter experts, a CFO can identify and assess insurable business risks and, if the risks cannot be fully mitigated through operational changes, secure adequate insurance coverage to protect the business.
Risk of Business Interruption
As a forward-thinker the CFO will support operations to formulate and implement a business continuity plan, ensuring redundancy of key processes and systems in the case of a significant business interruption.
A CFO can help business owners take short-term tactical actions to increase the value of the business. Tactics such as optimizing the tax structure improve the company’s value by increasing after-tax cash flow, while other actions increase the perceived value of the business.
Audit the Business
An audit offers assurance that the company is well-managed and no hidden financial, operational, or legal liabilities exist. The result is a higher perceived value of the business. However, stepping up from a compilation to a review or full audit can take up to two years to complete, which is why it is a critical action to take early on.
Optimize Tax Structure
The tax structure and accounting methods of the legal entity should work for the business. Optimizing these requires tactical actions, like utilizing flow-through entities to reduce overall tax burden. The goal should be to maximize the after-tax proceeds that are kept once the sale is final, not the price that is paid.
Sell Non-Operating Assets
Sell off any non-essential assets, like excess land, that can be removed without affecting business operations. Removing these assets improves liquidity to increase both short-term and long-term value.
Hiring a CFO
Many business owners struggle with the timing related to hiring C-suite positions. A CEO should bring on a CFO by the time a transaction is under consideration, and ideally, well before this point to effectively fuel long-term value growth.
Transaction experience is the most salient benefit of hiring a CFO. Experienced CFOs have worked with businesses throughout their lifecycle up to and including the sale and transition of the company. This experience includes a close working relationship with other specialized advisors (such as investment bankers, attorneys, and tax accountants) that can add value to the transaction. CFOs with varied career experiences typically bring the most current best practices to the role, including practices from outside the industry.
The CFO can also provide an objective view of the company, which is often lacking internally. An independent CFO can provide data-driven guidance to executive management and the board of directors. In the case of a family-owned business, owner operators may need the endorsement of an independent CFO to sway other family members.
Understanding the Lifecycle of a Business Transaction
A CFO with experience across the entire lifecycle of a business transaction will:
- Plan well in advance of a LOI (Letter of Intent) to purchase the business
- Manage owner expectations around the value of the business
- Review and optimize corporate tax and ownership structure – some structures take years to put in place
- Clean up the books and provide a view into the normalized cash flow of the business
- Sell non-operating assets, underperforming divisions, and pet projects
- Develop long-term value chain partners
- Understand capital flows in the industry – who is buying and selling and what factors are driving value
- Hire the right transaction advisors
The goal is not to sell the business for more – the goal is to keep more of the proceeds from the transaction.
The time to build long-term value is now. With the gift of time, an owner operator can work with a CFO to strategically position the company to maximize value. Ultimately, the planned end game for a company is inconsequential because increasing its value improves every foreseeable outcome. Furthermore, building value may create additional exit options.
The sooner business owners start, the more value they can build.
About the Author
Larry A. Breitbarth, CFA, is an experienced financial executive with a proven track record in executive financial management, strategic and operational planning, performance improvement, corporate controllership, project management, and valuation consulting. He began his career as a business valuation consultant with Arthur Andersen in Chicago and has served clients across a range of industries, including manufacturing and distribution, technology, retail and financial services