Enterprise value is an amount that represents the entire economic value of a
company. In essence, it is a measure of the takeover price that an investor would
need to pay in order to acquire a firm.
Calculated by adding a corporation’s market capitalization, preferred stock and outstanding debt together and then subtracting cash and cash equivalents, enterprise
value is a more accurate reflection of a
company’s takeover cost than market capitalization alone.
In order to increase enterprise value says
Lou Savett, managing principal of the
strategic transaction services group for
Gumbiner Savett Inc., it is important to
position your company for future earnings
growth. “The way to increase earnings is
by taking a hard look at your marketplace
and seeing to what extent you can expand
it,” he explains.
Smart Business spoke with Savett about
enterprise value, the importance of having
a strong management team in place and
how to best preserve the value of a business when in the selling process.
What steps can a company take to increase
its enterprise value?
First of all, a company has to make a
determination about where they fit in the
marketplace. There are wholesalers, retailers, manufacturers and service companies,
each of which has a separate group of component ingredients that make them more
or less valuable. Underlying all of that is
the fact that the enterprise value of a company is almost always determined by some
version of discounted future cash flow. If
you are able to diversify your market, if
you are able to get into areas where there
is less price resistance, if you are able to
get into rapidly expanding marketplaces,
then you are increasing enterprise value
because the future cash flows will be
greater than they are now. We also know
that pricing multiples change with regard
to the future components of the company’s
vision. If you are not growing then you are
unlikely to get a high multiple. If you are
growing very rapidly, in a way that people
believe will continue, you might get a multiple that is two or three times higher.
What is the main driver that affects the
enterprise value of a business?
The main driver will always be earnings
and the question will always be: What sort
of future earnings will a prospective buyer
be convinced can be attained? The higher
this number is the better off you will be.
Philosophically speaking, there are only
two ways to increase a business. One way
is to sell the same product to more people.
The other, is to sell the same people more
products. You need to do both of those
things. Wells Fargo Bank, for example,
recently bought an investment banking
group and a national insurance brokerage
company, expanding the services that they
can sell to their clients.
How can a strong management team
increase enterprise value?
A company needs to take a hard and sincere look at its management. Generally
speaking, when we walk into a company
there is usually one key person. If you ask
that person, he will quickly tell you that the
company is what it is because of his efforts.
If you tell that to a prospective buyer the
pricing multiple will be reduced — nobody
wants to take a chance on the genius being there forever. On the other hand, if you can
say we have a management team that
through thick and thin can run this company for its highest and best purposes then
the amount of enterprise value goes up.
What role does enterprise value play in
succession planning?
Enterprise value comes to the fore with
any type of exit strategy because it accurately predicts what the person or group
who is exiting will get in the way of benefits. When you do your succession planning, you want to build your enterprise
value up to a certain point. For example,
let’s say that your succession planning is to
put together an Employee Stock Ownership Plan. Your contributions to the plan
are in percentages of your capital stock, so
if the enterprise value keeps going up, you
put less shares in the plan and keep more
for yourself. You will get a bigger bang for
your buck tax wise if you continue to
increase enterprise value while you’re in
the midst of succession planning.
How can a business owner best preserve
the value of their business when in the selling process?
We advise our clients when they’re in the
selling process to bring together their core
management group and get them involved
in the selling process. If you don’t do that
people will get scared that their job doesn’t
have a future and either leave to a competitor or make other plans that aren’t in
your best interest as a seller. As you move
forward in the selling process it is important to determine what to tell your customers and vendors and when to tell them.
All of this has to be handled very delicately. If you don’t, and something goes wrong
in the selling process, you’re going to lose a
lot of value.
LOU SAVETT is managing principal of the strategic transaction
services group for Gumbiner Savett Inc. Reach him at (310) 828-9798 or [email protected].