Deal & Capital Prep: The Pillars Supporting and Maximizing Value

Welcome to the second article in our series on transaction preparation and better deal-making for small and midsize businesses (SMBs). This is a follow-up to the first article, Pointing the Arrow in the Right Direction and comes ahead of the third article, EBITDA is in the Eye of the Beholder. You can find more finance-related content on the First Water blog and get your hands on the definitive SMB finance function companion, Relational Finance, on Amazon (available in hardcover, Kindle, and audiobook formats).

What is value? If an EBITDA multiple falls in the forest, but nobody transacts, has value changed? Here, we'll discuss value as the relative ability to realize, monetize, and maximize. We'll largely avoid other value determinants that sit outside the realm of control of the SMB business leader or owner, such as interest rates, cost of capital, market risk premium, public equity comps, etc.

In the simplest of terms, we are talking about the ability to transact at all (sell or raise capital), get something attractive in return (upfront cash is better than being compensated in jelly of the month gift certificates), and to get the most of that attractive thing (moar jelly certificates! or cash, whichever you prefer).

Four pillars underpin the determination of business value: decipherability, credibility, growth story, and acceleration.

Let's tackle the pillars one by one.

Decipherability

Any party who analyzes a company for potential investment or acquisition expects a clear and accurate view of the business. Decipherability is the degree of insight into financials, operational data, structural integrity, and standalone operations. This boils down to the accuracy and completeness of your data, and the structural/compliance factors that allow the efficient analysis of whatever it is you are selling/pitching.

It should always be easier to look into a mirror than a crystal ball.

Poor decipherability can be a showstopper come deal time. Additionally, there may be aspects of decipherability which cannot be replicated over time. For example, if you have never tracked inventory levels and do not have accessible records of purchase history, you'll never (absent a time machine) be able to show what the average inventory levels need to be the manage the business at various times.

No matter how successful a company may be, keeping good records with efficient data capture is critical for future deal execution. The distillation of performance highlights the key trends leading up to this moment of time, and shows an investor/buyer that the ability is in place to understand and monitor operations, which contributes to...

Credibility

People and processes. Processes and people. We're not only the team to lead this business as-is, but we're also the team to take it to the next level. God forbid, even if one or more of us were to be hit by a bus, here are the processes and place that allow the business to recover and push forward.

Processes allow a company to establish its "Way" across all aspects of the managing the business, empowering the team while protecting against key man risk.

Credibility is established through management functions, financial controls and procedures, forward-looking analyses, and team communication and accountability. Is there competent leadership across all functions of the business? Controls in place to support the business as teams and operations expand? Can the team leverage data to inform projections, and do they have the tools to build credible operational and financial outlooks? Do these outlooks support and inform target setting, and are team members held accountable to results?

These items are critical for a team with big aspirations, especially when those aspirations represent uncharted waters beyond the team's experience to date. Further, repeatable processes and forward looking capabilities show that the team has done its diligence in preparing the business for its....

Growth Story

Here is where we are heading, with the team and credible plan to convince you the prospective return is worth the risk.

Successful deals are characterized by a mastery of storytelling.

We often talk about how the best part of finance is storytelling, and this may be most prominent when it comes to deal-making. Check out our plan, the associated credible financial outlook, and the additional opportunities that await us along the path. The better the growth story, or at least the better the persuasion, can have a big impact on valuation and the terms of the deal.

A compelling growth story has four distinct components: 1) the different channels for organic and inorganic growth, 2) the market/sector outlook for the timeline being considered, 3) the capital roadmap attached to the growth roadmap, and 4) the alignment of the growth and capital roadmaps with the target risk-return profile of the counterparty.

Every deal is predicated on a story about the future (see that previous article!), and growth stories are the most attractive. This works best when the story is not only defined, but already in motion, as evidenced by...

Acceleration

Acceleration is considered the "nice to have pillar" for business value, if only because it is not always possible to show acceleration when 100% of the growth story is tied to getting the deal done and capital in the door.

Progress toward the plan provides additional credibility for the team, plan, and growth story.

However, for organic growth, acceleration means acting on core pieces of the plan. Progress provides additional credibility for the team, plan, and growth story. Building pipeline and rationalizing costs go a long way toward mitigating the perceived risk associated with projections showing top-line and bottom-line growth.

Often, the growth story and corresponding transaction thesis represent a shift or pivot from historical operations. An example would be an M&A strategy to grow via acquisition. This is one of the "chicken and egg" examples where you need the capital first to get the actual growth. However, nothing stops you from building a target list. That's still acceleration by compressing the time required to act when everybody says GO.

Coming Next

EBITDA, EBITDA, EBITDA, EBITDA...with a side of EBITDA.

Ben Lehrer is the CEO at First Water, a Houston-based advisory firm connecting teams with data and companies with capital through Relational Finance. First Water delivers the power of big company finance departments to smaller businesses to help SMB leaders and owners harness data, look forward, assess options, attract capital, and transact with confidence in pursuit of their goals. Connect with us here on LinkedIn, leave comments below, and join our community to get the latest in finance content.