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
makes it 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, get into
areas where there is less price resistance
and 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 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 it
can sell to its 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
involves putting 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 business owners best preserve the
value of their business when in the selling
process?
We advise our clients 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.