How to Maximize Enterprise Value

By: Barry Calogero

How much is your business worth?? Whatever someone is willing to pay.? Possibly trite, but true.??

Boosting your company’s enterprise value is priority #1 – and that starts with understanding key quantitative and qualitative components of that value calculation from the perspective of a potential acquirer. Armed with that knowledge, you can make operational decisions and growth strategies designed to enhance value in both the near and long term. In the second article of this series, we dig into a couple of these key concepts.?

Quality of Revenue?

Great strategic customers and highly valued work form a strong company foundation, but the revenue generated needs to be profitable. Marginally profitable revenue consumes significant resources, but it doesn’t garner much value in a sale. To maximize your enterprise value, you should take your scarce resources and focus on opportunities, parts, and customers where you can make a good profit. Identifying and pursuing these initiatives means training salespeople and operations staff accordingly. In generating more profit (EBITDA)1 on each revenue dollar, a company highlights the efficiency and effectiveness of its operations.??

There are times when less profitable revenue is worth a lot – such as when gaining a new and important customer or entering a new market to get a foothold. In these cases long term strategy may outweigh near term accounting, and it is a management decision. Overall, however, 15% EBITDA is better than 5%.?

Revenue Sources: Customer Concentration & Contract Types?

Where the revenue comes from and the conditions under which it is earned are also critical, in large part because they speak to the future of the business, which is of great interest to an acquirer. In the A&D world, unlike many other sectors, having a majority of revenue come from one customer is more frequently thought to reflect demonstrated expertise and strong roots, rather than a source of risk for the business. Small amounts of work, especially if unspecialized, for many customers, would indicate a lack of those same attributes. The only caveat of this approach to business in the A&D world is that if the vast majority of the revenue is tied in with one contract, there may be risk associated with the contract or program. Ideally, companies build a revenue profile with some diversity of customers and contracts that also reflect high value product and service offerings.?

Contract types also affect value in the eyes of an acquirer. For example, prime contracts, either directly with the government purchaser or with the leading prime, speak to a company’s relationship with the key decision-makers and ability to influence renewals, follow on work, or expansion. Subcontractors may enjoy direct relationships but may also be relegated to the backseat. Another critical issue is whether work was won through a limited competition program accessible because of the company’s status. If a company’s revenue is tied to contracts won through limited competition or “setaside” programs (see below), that revenue may be less valuable to an acquirer than revenue attached to contracts won in full and open competition. This says nothing about the quality of the products or services provided – it simply reflects the reality that acquirers (unless they have and maintain the same designations) will not be able compete on that same basis when those contracts are up for renewal.?

Company Status & Other Attributes?

In the A&D world, most smaller companies work as suppliers to other companies in a value chain that eventually lands at the government (defense work) and/or leading prime contractors, like Boeing or Lockheed Martin. Generally, the closer a company is to the top of the chain the more valuable (and visible) its work – a Tier 1 supplier to the OEM is better positioned than a Tier 2 or 3 supplier.?

A company’s designation as a Small Business (certified by the SBA2); a minority-, veteran-, or woman-owned business; or an 8(a)3 company can also affect its value, in the event that these designations are factors in its contracts (see above).?

Specialized service offerings and unique technology drive up value. Critical path suppliers in important programs, especially if there are few or no alternatives, will always be more valuable than companies providing commodity products. Other suppliers in the chain may well want to reduce risk by bringing the provider “in house” through an acquisition.?

EBITDA Addbacks?

Companies are frequently valued by acquirers as a multiple of EBITDA, and while EBITDA is a fairly straightforward accounting measure, it is usually “adjusted” to better reflect the actual ongoing operating performance of the company on a standalone basis. These adjustments, often called addbacks, can cover a variety of expenses which are generally added back to increase EBITDA. For example:?

• One-time expenses: Implementation of a new ERP4 or CRM5 system; legal fees associated with a singular lawsuit; severance costs for an executive employee.??

• Adjustment for “excess (above market) compensation”: A company paying owners or senior team members above market compensation in terms of a salary or a bonus that would be adjusted post-closing to normal market level.??

• Personal expenses (usually of owners) that were paid by the business but are not necessary for the business: Personal travel; personal cars; premium healthcare policies.?

Adjustments can go the other way. If an owner is not paid a salary and is instead taking income through distributions, the EBITDA will be adjusted downward for the equivalent market-based compensation for the owner’s work.???

Defining and accurately tracking each addback, over several years at least, is important. Every dollar of EBITDA can represent 5x, 10x, or even more in purchase price.? The company’s CFO or controller should track all of these expenses closely and separately – the value cannot be claimed if it can’t be proved.?

Acquirers assess risk in every aspect of valuation and one of the greatest possible risks is what will happen with the CEO post-closing. Most buyers want the leader to remain engaged with the business, whether for a short or long period of time, which means that the greater the succession depth and the more flexibility the owner has, the stronger the valuation.??

If you understand your company’s value drivers as viewed by the market, you are equipped to make strategic operational adjustments (as possible) and highlight the company’s key selling points. In the next article of the series, we look at steps to prepare a business for a transaction. With preparation and insight, you will be better positioned to communicate your company’s value to the universe of potential buyers.?