Buyers, as part of their due diligence, usually employ accountants to check the numbers and attorneys to both look at legal issues and draft or review documents. Buyers may also bring in other professionals to look at the business’ operations. The prudent buyer is also looking behind the scenes to make sure there are not any “skeletons in the closet.” It makes sense for a seller to be just as prudent. Knowing what the prudent buyer may be checking can be a big help. A business intermediary professional is a good person to help a seller look at these issues. They are very familiar with what buyers are looking for when considering a company to purchase.

Here are some examples of things that a prudent buyer will be checking:

Finance

• Is the business taking all of the trade discounts available or is it late in paying its bills? This could indicate poor cash management policies.
• Checking the gross margins for the past several years might indicate a lack of control, price erosion or several other deficiencies.
• Has the business used all of its bank credit lines? Does the bank or any creditor have the company on any kind of credit watch?
• Does the company have monthly financial statements? Are the annual financials prepared on a timely basis?

Management

• Is the owner constantly interrupted by telephone calls or demands that require immediate attention? This may indicate a business in crisis.
• Has the business experienced a lot of management turnover over the past few years?
• If there are any employees working in the business, do they take pride in what they do and in the business itself?

Manufacturing

• What is the inventory turnover? Does the company have too many suppliers?
• Is the business in a stagnant or dying market, and can it shift gears rapidly to make changes or enter new markets?

Marketing

• Is the business introducing new products or services?
• Is the business experiencing loss of market share, especially compared to the competition? Price increases may increase dollar sales, but the real measure is unit sales.

When business owners consider selling, it will pay big dividends for them to consider the areas listed above and make whatever changes are appropriate to deal with them. It makes good business sense to not only review them, but also to resolve as many of the issues outlined above as possible.

Take two seemingly identical companies with very similar financials, but one of the companies was worth substantially more than the other company.  One company will sell for $10 million “as is” or some changes can be made and the same company can be sold for $15 million. Following is a partial list of potential company weaknesses to consider in order to assess a company’s vulnerability.

Customer Concentration:  First, one has to analyze the situation.  The U.S. Government might be considered one customer but from ten different purchasing agents.  Or, GM might have one purchasing agent but be directed to ten different plants.  One office product manufacturer with $20 million in sales had 75% of its business with one customer…Staples.  They had three choices: 1. Cross their fingers and remain the same; 2. Acquire another company with a different customer base; or 3. Sell out to another company.  They selected the third choice and took their chips off the table.  The acquirer was a $125 million competitor which was unable to sell to Staples, so after absorbing the smaller company, the customer concentration to Staples was only about 10% ($125m + $20m=$145m of which $15 million was sold to Staples or 10+%).

Single Product: Perhaps the most famous example of a single product acquisition is when General Motors overtook Ford’s single product, the Model A, with Alfred Sloan’s brilliant concept of a different model for people with different financial thresholds.  Henry Ford’s stubbornness to stay with one product (Model A) almost cost the company its existence.

Regional Sales/Limited Marketing:  Companies with parochial focus have limited capabilities to grow other than within their own domain.  A widget company with national and international sales has substantially greater prospects to grow than one limited to its own region.

Aging Workforce/Decaying Culture:  Skilled workers in certain trades, such as tool and die shops, are not being replaced by the younger generation.  This is a sign that the next generation will not provide the companies with a skilled workforce in certain industries.

Declining Industry:  Some companies are agile enough to completely change their industry, such as Warren Buffet’s Berkshire Hathaway and Fashion Neckwear Company which completely changed from neckties to polo shirts.

Pricing Constraints/Rising Costs: Companies who sell a commodity product often lack pricing elasticity and are unable to pass on their increased costs to their customers.  For a while, the steel industry was in this predicament, but through massive industry consolidation and a booming demand from China, the situation changed.

CEO Dependency/No Succession Plan: Many middle market companies have successfully been built up by the founder/entrepreneur/owner and some critics call these individuals a “one-man-band” for good reason.  These superman types tend to dominate most aspects of the company, but this is no way to build a sustainable business long term.  Furthermore, these CEOs usually have not created a succession plan.

Maximizing Value

If the owners of a company, many of whom may be outsiders, want to increase the value of their investment, they should, through the Board of Directors, try to overcome the company’s weaknesses.  On the other hand, the CEO may not be either capable or motivated to do so.  The alternative is to implement a CEO succession plan, preferably with the cooperation of the current CEO.  Kenneth Freeman’s thesis in “The CEO’s Real Legacy” (Harvard Business Review, Nov 2004) is that the CEO’s real legacy is implementing a succession plan.

Freeman advises:

“Your true legacy as a CEO is what happens to the company after you leave the corner office.

“Begin early, look first inside your company for exceptional talent, see that candidates gain experience in all aspects of the business, help them develop the skills they’ll need in the top job…

“During good times, most boards simply don’t want to talk about CEO succession…During bad times when the board is ready to fire the CEO, it’s too late to talk about a plan for smoothly passing the baton…Succession planning is one of the best ways for you to ensure the long-term health of your company.”

Both buyers and sellers should assess the company’s weaknesses.  While some weaknesses are difficult to overcome, especially in the short term, one potential weakness that is very easy to overcome is to implement a succession plan…especially during the company’s good times before things go bad and it’s too late.