When I bought my first condo, there were a lot of changes I wanted to make and changes I needed to make. The initial inspection uncovered a leaky hot water heater. I required the prior owner to replace it as part of the closing process. After moving in, I painted some walls; I bought a new microwave; I modernized some of the lighting; it was great. But all along the way, I kept asking myself, “Will this affect my selling price? Should I pull up the carpet and put down hardwood floors just because it will increase the value?” I think these are questions that every home buyer goes through. But how far into your home ownership do you stop wondering about selling? How long does it take before you don’t even care about the selling price and you settle in and make it your “home”? How long before you sell do you let some preventative maintenance duties slip? If you or someone you live with wants to paint their bedroom blaze orange, do you do it? These are the types of questions and issues that go through all homeowners’ heads. But they should (and probably do) go through a business owner’s head and board of directors’ heads as they consider a corporate acquisition.
Most financial analysts will tell you that the value of a business is the combination of its assets and its free cash flow (or future estimated revenue). But when selling, merging, or obtaining private equity investment, certain other conditions can also affect the selling price as well as the time needed to locate a buyer. Would you purchase a house that had a blaze orange bedroom? You would if the house was in the perfect neighborhood, was the perfect size, and you didn’t mind painting a few walls. But if you had your choice of an identical house across the street and all of the rooms were painted colors you liked and only few other upgrades were required, you would probably prefer and possibly purchase that house. The same is true in business acquisition.
Let’s take a look at a private equity investment as an example. When a private equity firm is interested in a target company, they perform a diligence, similar to an inspection. Based on those results, there may be activities they require the target company to purchase or replace prior to the deal closing. Just like my hot water heater, the target company may need to true-up their software licenses or take care of some other projects that are midstream. The diligence may also uncover things that will need to be done as soon as the deal closes. Have a blaze orange bedroom? That’s the first to go. High-tech company in hurricane territory without a disaster recovery plan? Finish it in the first 100 days.
Now, I’m not trying to say that you should always be thinking about selling your business and not paint your bedroom blaze orange. But you should be cognizant of things that could affect your selling price or items that would affect your reputation or turn a potential investor away. Like maintaining your roof or making changes that you enjoy as well as increase the value of your home (e.g. hardwood floors, granite counter tops, etc.), the following are just a few we have uncovered from the many diligences West Monroe Partners’ has performed:
- Maintain a well-documented disaster recovery or business continuity plan
- Keep good software licensing records and license count accurate and up-to-date
- Maintain a consistent IT strategy and on-boarding process
- Utilize efficient IT processes, so your staff count is remains at an appropriate level
- Leverage outsourcing when possible to contain costs
- Maintain an IT budget with plans projecting at least to the next 3 to 5 years
- Ensure key business systems are stable and have a defined capacity plan
There are many other things that a PE firm will look at when interested in a potential target company, and there will always be improvements that can be done after the deal closes. But it is always a good idea to keep the house in order as to not draw attention, affect your reputation, or affect the overall selling price of the target company. I don’t know how many times I’ve run into a mid-market target company without a disaster recovery plan. It rarely prevents the deal from going through, but it definitely says something about the maturity and priorities of the IT organization and is likely to impact the purchase price. Like the blaze orange bedroom or a leaky roof, make sure your company appears as desirable as possible when seeking potential buyers.