Exit Strategy: How to Maximize Your Company's Value
Written by Stephen Hassett
You’ve spent years building your business and for whatever reason you are ready to sell it. How do you maximize value? Unfortunately, you may be too late. The value creation process needed to start years ago and short-term fixes may actually make things worse. In order to understand why, it helps to start with the stock market.
When many people think of the stock market, they conjure up images of the 1987 movie, Wall Street complete with its crazy co-star, Charlie Sheen. The truth is far from that. Over long term, the market is in fact, not only rational, but it is easy to understand and almost reptilian in response to readily observable factors. The ways of the market are actually simple and straight forward.
To maximize value you want to have sustainable growth and strong cash flow (earnings). It’s that simple. Instead, many people believe the market is almost arbitrary in assigning values. This leads to bad decision making.
One of the main metrics used to compare values between companies is the P/E ratio, which is simply the value of a company divided by its earnings or the share price divided by its earnings per share. If Company A earns $1.50 per share and its stock price is $15.00 then its P/E ratio is 10. If Company B’s stock price is $30 with the same $1.50 in earnings, then its P/E ratio is 20. This implies that for every ten cents per share that Company A adds it will increase its share price by $1.50, while Company B will increase by $3.00. So obviously you want a high P/E ratio, but how? Why aren’t all dollars the same? Why do some companies command a premium?
Differences in the P/E ratio among healthy companies are driven by one thing – expected long-term growth. (You can learn why and about the model behind this in my book, the “The Risk Premium Factor.”)
The relationship is simple – if your expected growth rate increases so does your P/E ratio and your company becomes more valuable. Likewise, slower growth means a lower P/E ratio. Before going any further, it helps to understand what this growth rate means. It is the expected long-term growth in earnings or cash flow, meaning that on average your investor expects the company to grow at this rate forever. Now here is a mistake that many people, even sophisticated investors, make. They don’t grasp that the growth rate is based on investors’ long-term expectations for the future, not what you did last year and not what you expect to do next year. Misunderstanding this can cause serious problems.
If you have grown earnings over the past several years by cutting cost and not growing revenue, investors are not going to be convinced you have a long-term growth story because you can’t cut costs forever. In order to have a good growth story, you need to show the ability to grow the top line and the bottom line.
Investors have to believe your story. You won’t get credit for growth, if they don’t believe it’s sustainable. Creating the growth story takes time, which is why starting when you’re ready to sell is too late.
If you want to show bottom line growth by beginning to cut costs a year or two before you’re ready to sell, rather than creating a growth story, you many destroy value by making decisions that sap your top line growth. Here’s how.
Let’s assume your business has been growing at a modest 5 percent per year and earns $1 million. If a would-be buyer believed that you could sustain that growth, based on my model, we could expect them to pay you 20 times or $20 million. Rather than take the $20 million, you decide to boost earnings by cutting sales expense by $500,000 and the result boosts your bottom-line at the expense of revenue growth which drops to zero. The savvy investor will see that you have a healthy $1.5 million in earnings but no growth. Since you can’t cut costs forever, they may assume your long-term growth rate is zero. Based on my model, the result is that your P/E ratio drops to 10, so the value of your business actually drops to $15 million despite the increase in profits.
Not only do investors value growth, but they are smart. M&A professionals know the difference between sustainable and unsustainable growth. Simple common sense says the best way to create that growth story is to start early and invest wisely. Less wide known is the fact that your growth story is one of the most important drivers of value.
About the Author: Stephen D. Hassett is a corporate development executive with Sage North America, a subsidiary of The Sage Group plc, a leading global supplier of business management software and services and author of "The Risk Premium Factor: A New Model for Understanding the Volatile Forces that Drive Stock Prices" (Wiley 2011).
Six issues at the top of tax and finance leaders’ agenda
New Deloitte research reveals that tax leaders are under increasing pressure to add strategic value as companies accelerate business model transformation, from undergoing digital transformations to rethinking their supply chains or investing in green initiatives.
According to Phil Mills, Deloitte Global Tax & Legal Leader, to “truly deliver value to the business, the tax function needs to rethink its resourcing model and transform its technology infrastructure to create capacity and control costs”.
And the good news, according to Mills, is that tax and business leaders have more options at their disposal to achieve this.
Reflecting the insights of global tax and finance executives at global companies, Deloitte’s Tax Operations in Focus study reveals the six issues at the top of tax and finance leaders’ agenda.
Trend 1: Businesses seek more strategic counsel from tax
Companies are being pushed to develop new digital products and distribution channels and accelerate sustainable transformation and this is taking them into uncharted tax territory. Tax leaders say their teams must have the resources and skills to give deeper advisory support on digital business models (65%), supply chain restructuring (49%) and sustainability (48%) over the next two years. This means redrawing the boundaries of what tax professionals focus on, and accelerating adoption of advanced technologies and lower-cost resourcing models to meet compliance requirements and free up time.
According to Joanne Walker, Group Tax Director, BT Group PLC, "There’s still a heavy compliance load today, but the vision for the future would be that much of that falls away, and tax people become subject matter experts who help program the machine, ensure quality control, and redirect their time to advisory activity.”
Trend 2: Tipping point for resourcing models
Business partnering demands in the tax department are on the rise, but 93% of tax leaders say their department’s budget is remaining flat or falling. To ensure that the tax function can redefine itself as a strategic function at the pace that is required, leaders are choosing to move increasing amounts of compliance and reporting to a combination of shared service centers, finance departments, and outsourcing providers that have invested in best-in-class technology.
Trend 3: Digital tax administration is moving faster than expected
in addition to the rising focus of the corporate tax department partnering with their business counterparts, transformative changes to the way companies share tax information with revenue authorities is also creating an imperative to modernize operations at a faster pace. Nine in 10 (92%) respondents say that shifting revenue authority demands on digital tax administration will have a moderate or high impact on tax operations and resources over the next five years—and several heads of tax said the trend is moving faster than expected.
"It’s really stepped up in the last couple of years," says Anna Elphick, VP Tax, Unilever. "Tax authorities don't just want a faster turnaround for compliance but access into a company’s systems. It's not unreasonable to think that in a much shorter time than we expect, compliance will be about companies reviewing a return that's been drafted by the tax authorities."
Trend 4: Data simplification and lower-cost resourcing are top priorities
Tax leaders said that simplifying data management (53%) and moving to lower-cost resourcing models (51%) must be prioritized if tax is to become more proactive at delivering strategic insights to the business. Many tax teams are ensuring that they have a seat at the table as ERP systems are overhauled, which is paying dividends: 56% of those that have introduced NextGen ERP systems are now highly effective at supporting the business with scenario-modeling insights. Only 35% of those with moderate to low use of NextGen ERP systems said the same.
At Stryker, “we automated the source P&L process for transfer pricing which took a huge burden off of the divisions," says David Furgason, Vice President Tax. "Then we created a transfer price database to deposit and retrieve data so we have limited impact on the divisions. We are moving to a single ERP platform which will help us make take the next step with robotics.”
Trend 5: Skillsets are shifting
Embedding a new data infrastructure and redesigning processes are critical for the future tax vision. Tax leaders are aligned — data skills (45%) and technology process experience (43%) are ‘must have’ skills in a tax department of the future, but more traditional tax specialist knowledge also remains key (40%). The trick to success will be in tax leaders facilitating the way these professionals, with their different backgrounds, can work together collectively to unlock lasting value.
Take Infineon Technologies, which formed a VAT technology and governance group "that has the right knowledge about how to change the system to ensure it generates the right reports", according to Matthias Schubert, Global Head of Tax. "Involving them early was key as we took a greenfield approach, so we could think about what the optimal processes would look like and how more intelligent systems could make an impact
Trend 6: 2020 brought productivity improvements
Improved productivity (50%) and accelerating shifts to remote working (48%) were cited as the biggest operational benefits to emerge from COVID-19-driven disruption. But, as 78% of leaders now plan to embed either hybrid or fully remote models in the tax function long term, 34% say maintaining productivity benefits is a top concern. And, as leaders think about building their talent pipeline and strengthening advisory skill sets, 47% say they must prioritize new approaches to talent recognition and career development over the next two years, while 36% say new processes for involving tax in business strategy decisions must be established.