Benchmarking in 2020 – Key Business Metrics to Monitor

Benchmarking in 2020 – Key Business Metrics to Monitor

As you start the new year, it’s advisable to pay attention to areas of your business to identify problems, resolve issues and measure growth.

Business owners at all stages should follow benchmarking practices – but owners considering selling their business soon or in the future should be especially vigilant.

Likely, you already track some performance metrics in your business, such as profit and EBITDA. While profitability and EBITDA are very important, there are others that many business owners overlook.

Let’s look at some metrics that are equally valuable.

Gross Profit Margin Per Revenue Source and Service

Business owners should review each revenue component whether it be products or services and analyze both the revenue and expenses associated with each. They should also really look at the 80/20 rule in terms of the gross margin per revenue or product.

When is the last time you really studied or analyzed each one of your product or service areas based up on gross margin contribution to the company – including all costs associated with each revenue source? Does a revenue source have disproportionate expenses?

Are these expenses worth the revenue that it brings into your company?

Are there expense components that can be bettered utilized in other parts of your business?

Studying your profit margins across your spectrum of products and services is crucial in bettering your company’s profitability.

Monthly Recurring Revenue Metrics

It is very important to the profitability and value of your business to provide services with monthly recurring revenue. If you do have recurring revenue, you should analyze the cost associated with that revenue (client acquisition, service expansion upgrades, client churn) and understand what percentage of your customers you are keeping, what percentage you are losing and why.

If you do not currently have services that provide monthly recurring revenue, now is the time to put creativity, thought and effort to develop that side of your business

Labor Loaded Gross Margin

If you are running a service business and you have a lot of clients, you need to examine the cost associated with generating gross margin.

Pay attention to which clients demand a disproportionate amount of attention and resources. By looking at profit margins you’ll be able to identify which clients are receiving too much time.

Effective Hourly Rates Spent Servicing Clients

It’s necessary to understand exactly how much it costs to service a client. Once you determine that figure, you’ll know whether you need to charge more. It’s certainly not a good business practice to lose money on a client.

If you can’t make money on the client, then you may need to fire that client or have a frank discussion with the client. So, calculate this metric for each client, analyze the results and increase your monthly fees when necessary.

Customer Contribution/ Client Concentration

While large and loyal customers are an asset to your business, customer concentration of too many large clients (in relation to your total customers) can be a red flag when you are raising capital to expand your business or selling your business. Keep track of customer concentration so that your customer portfolio is in balance and that your customers are evenly distributed across your customer base.

Client Churn Rate

How many clients do you lose each month? And why?

You should be tracking this statistic in your business. Some churn is inevitable but a sudden decrease in customers means you need to take a look at your business. Is it an employee issue? A product or services issue? Are you losing business to a competitor?

The sooner you identify the issue and act to correct course, the quicker your business will recover and rebound.

Employee Churn Rate

Your employees are your biggest asset.

Are you retaining employees? If you are not, why aren’t you?

Is it because of ineffective managers?

Lack of training? What can you do to better train your employees?

What can you do to cut down on this rate?

Are your compensation plans competitive? Are you rewarding and recognizing your employees?

How do your employees stack up against your competition?

Conversion Rate

How many client leads do you actually convert into new clients? Generating leads is great but a good conversion rate is critical to the success of your business. It’s also important to understand lead source and testing new lead generation strategies when necessary.

Return on Investment

Any time you spend money in your business should be done with the intention of calculating the return on both the soft (employees, etc.) and hard (actual cost of goods – equipment, software, web development, social media, online branding, supplies, etc.) to generate that income. Understanding this information – and making adjustments based on it – is critically important..

Conclusion

There are many metrics to choose from in running your business. The most important thing is to choose the ones that will benefit you the most in growing and maximizing profits for your business. And, in the end, using good metrics will pay off for you when its time to exit and sell your business. Buyers do pay more for well-run businesses with strong processes in place.

 

This article was written by Harvest Business Advisor Partner, Richard Stopa.


Clients choose Harvest Business Advisors for our accurate business valuations and our proven ability to deliver the highest price in the smoothest sale transaction possible. Harvest Business Advisors provides business brokerage, business valuation, and business succession planning services. We have extensive experience in the information technology and professional services, manufacturing, distribution, and contracting fields. We maintain offices in Maryland, New Jersey and Virginia. Connect with us at info@harvestbusiness.com or 877-838-4966 to discuss selling your business, ordering a business valuation or buying a business.

 

 

Selling Your IT or Software Business (video)

Selling Your IT or Software Business (video)

The business brokers at Harvest Business Advisors have worked with several IT companies, finding individual buyers or companies interested in a merger for these sellers.

In many ways, selling an IT company is no different than selling any other companies. But the IT company owners need to consider a few key characteristics of these sales, as discussed in this short video:

As with any other business, maintaining profitability is critically important, as well as implementing services that would result in recurring revenue.

Having all processes well-documented is vital and retaining key employees is a selling point.

Finally, consider a business valuation to help set your asking price. Knowing and demonstrating your businesses value means a reasonable asking price (and more profit for you).


Clients choose Harvest Business Advisors for our sage advice on profitably growing their business, accurate business valuations, and when the time is right, a consistent ability to deliver a high price as part of a smooth exit transaction.

We maintain offices in Maryland, New Jersey and Virginia. Connect with us at info@harvestbusiness.com or 877-838-4966 to discuss selling your business, ordering a business valuation or buying a business.

How To Sell Your Business, Part Eight — Closing the Sale

by Greg Caruso, JD, CPA, CVA and Partner at Harvest Business Advisors

Once the negotiations have been completed, the transaction moves to the closing stage. During this time, final price adjustments are made to take into account any last minute inventory additions or deletions, accounts receivable, pro-rated operating costs and any other variables that may arise. Also at this time the purchase agreement and any loan documents are assigned. Leases, contracts and titles are transferred, and new agreements such as non-competes are signed.

 

Transfer of Licenses  This very often involves a liquor license but many different types of businesses and professions require a license.  In some instances, the license transfer occurs after settlement.  Before the sale process starts, all required licenses and the transfer requirements should be identified and investigated.  Factor these requirements into both your sale schedule and preliminary qualifications for a Buyer.

Franchiser or Supplier Approval and Disclosure  A Hallmark Store is not worth much if Hallmark does not approve the Buyer and does not agree to ship inventory to them.  Again, check out the requirements prior to starting the sale process.  Many franchisers and suppliers have written standards, or they will give you oral standards, so you can qualify your prospects.  These standards may be both financial and academic.

Bank Financing Approval  Bank approval, particularly SBA bank approval, can be a frustrating challenge.  It requires careful coordination and constant pushing by the borrower, and it is important to get all documents to the bank as quickly as possible.

Unfortunately, the nature of underwriting is that one document request generally leads to another.  If a typical loan process requires five additional document requests (not abnormal), and each request takes two days for you to complete and three days for the bank to review and make a new request, then the detailed underwriting will take about five weeks.  If it takes you five days to produce the information, then the process stretches to eight weeks.

Keep pressure on the bank and produce the requested documents as quickly as possible.  It also pays to start with a professional bank package.  If you do not know how to prepare one find a loan broker, consultant, or accountant who can help you get it done right.  A professional appearance is worth the price and effort.

Landlord Approval  Leases need to be assigned to the new Buyer.  Landlords always retain the right to approve this.  Depending on your landlord, this can be the easiest approval or next to impossible.  Unfortunately, the landlord with whom you started your business may not be the landlord who approves your lease transfer.  While most leases call for reasonable approval (but not all, check when you start the process), reasonable can be a very difficult thing to prove.

Many Sellers do not want to look into this until they have a Buyer but it really makes sense to investigate this in the beginning.  Some landlords routinely charge a small fee to transfer leases.  More than one has tried to raise the rent and take a percentage of the sales price when approached.  Receiving a lease assignment may be very difficult if your landlord is greedy and the property location is in demand.

Closing Adjustments  Often inventory and other balance sheet accounts (if being conveyed or assumed) will be adjusted as of the settlement date. It makes sense for a third party company to take inventory.  They will come in and get the job done in hours instead of the days it will often take you.  You do need to be present to look up costs, and the Buyer should also be there to verify the process.  You want the Buyer involved and to perform reasonable due diligence.  Now is the time to solve problems, not through a lawsuit after closing.

In fact, your attorney should try to obtain a clause in the contract which states, “the Buyer has been able to perform all investigations desired including but not limited to appraisals, environmental investigations, inspections, accounting reviews and testing etc., and is buying the business based on the results of those investigations and not on preliminary information and summaries provided.”

Transaction Expenses . Everything is negotiable but typically in our market the Seller picks up the brokerage fee.  The Buyer pays the loan costs, taxes, and recording expenses.  The parties split the settlement and closing costs.  Both parties pay for their own counsel.  Generally the Buyer pays part of the Seller’s legal fees if the Seller is taking back financing. They would pay an outside lender for this so, if the amount is reasonable, covering the Seller’s legal expense for loan documents is reasonable too.

Document Review We firmly believe that, prior to the time of settlement, all terms and conditions should have been agreed to and reviewed by the parties.  In general, your attorney will sign off on the format and wording of the final documents.  If third party financing is involved, signing off will be very last minute as often the bank documents and final fees are the last items to arrive – sometimes an hour or two after you intended to start closing.

Closing and Settlement Some Buyers and Sellers keep negotiating right up until the pens are placed down and the check exchanged.  If you must do this, remember that next week you may need something from the other party.  Business sales are different from real estate transactions in that businesses have many moving parts and many people involved.  In typical real estate transactions, after closing, the Buyer and Seller have very little interaction.  With business transactions, the interaction may continue for years.

You should receive copies of all documents.  Some attorneys prepare elaborate closing packages and forward the documents, including the sales document, all exhibits, a worksheet for the money, loan documents, and legal conveyance documents etc., several weeks after settlement.  While somewhat expensive (someone is paying for it), these packages are helpful when questions arise later.

 


Clients choose Harvest Business Advisors for our accurate business valuations and our consistent ability to deliver the highest price in the smoothest sale transaction possible. Harvest provides business brokerage, business valuation, and business succession planning services. We have extensive experience in the information technology and professional services, manufacturing, distribution, and contracting fields. We maintain offices in Maryland, New Jersey and Virginia. Connect with us at info@harvestbusiness.com or 443.334.8000 to discuss selling your business, ordering a business valuation or buying a business.

How To Sell Your Business, Part Seven — Structuring and Negotiating the Deal

by Greg Caruso, JD, CPA, CVA and Partner at Harvest Business Advisors

Up to 60% of the profits of a poorly structured business sale may end up in the income tax coffers.

Disclaimer:  This post only provides a brief amount of information on a very technical and complex area of law.  Only use it to ask questions of your competent tax advisor and never for detailed planning purposes or to negotiate a transaction.  Additionally the tax code and legal interpretations of it are constantly changing.  Again, obtain from your advisors good current advice specific to your situation.

Internal Revenue Service provisions and the tax consequences of a business disposition or merger and acquisition need to be considered at the earliest point in the strategic planning and deal making process.  In most cases, careful planning can help avoid ‘worst-case’ tax liabilities.

This post addresses the tax implications of selling a business either as a stock sale or as an asset sale.  By the end, you should have a working knowledge which will enable you to review the concepts with your tax advisors.   This is not tax advice, just information about ways your advisors might be able to help you.  Do not make final tax decisions or enter into firm contracts without reviewing every move with qualified tax professionals.  Seemingly minor changes in structure can result in major changes in tax liability.

 

Stock Sale

The most basic business sale transaction is the stock sale.  The ownership of the business is sold and the business itself remains fully intact.  Everything owned by the business continues to be owned just as before.  If you, as the Seller, have assets or liabilities that you need to retain, you can spin them out to yourself or to another entity you are keeping prior to the sale, and then deduct them against the proceeds.

Stock sales are generally good for Sellers.   They are taxed at the capital gains rate, which is significantly below ordinary income rates, just like when you sell stock on the public stock exchanges.  The Buyer, on the other hand, gets very few tax advantages from this structure.  Existing assets continue to be depreciated based on the Seller’s schedule.  More difficult for the new Buyer is that he or she cannot amortize the Goodwill.  In accounting terms, Goodwill is the difference between the hard asset value and the total business price or value when you buy or value a business.

In certain cases, assets can be marked up like an asset sale clearing up the Buyer’s inability to amortize good will.  (See your tax advisor early if you intend to take this approach.)  This still leaves one major stumbling block:  the Buyer has assumed all the known and unknown liabilities incurred by the Seller.  Because of the liability issues in smaller transactions, Buyers favor asset sales.  One exception is when the business has valuable licenses and contracts (think defense contractors with government contracts) in the company name that will not transfer to a new entity.

Asset Sale

A business may also sell its assets.  In an asset sale, generally all the assets and benefits of the business are sold while the liabilities and problems are retained by the Seller, or at least clearly not purchased and assumed by the Buyer.

In asset sales each asset class has its own tax treatment.  Inventory is generally sold at wholesale cost which usually is its tax basis.  In those instances, it does not result in tax liability.  Equipment value above the tax basis usually is taxed at ordinary income tax rates because of depreciation recapture rules.  New Goodwill and new intangibles are taxed at capital gains rates.  The non-compete is taxed at ordinary income rates because it is considered to be a payment for services.  This all means that the Seller’s tax implications can vary dramatically based on the agreed asset valuation schedule.

 Your obligation to the IRS is to report the fair and correct values.  The Seller and Buyer must agree on these values and report the same ones.  The Buyer fares better in this transaction by having the equipment valued high.  These assets can be deducted for tax purposes very quickly though depreciation.  This future tax deduction will provide the Buyer with more after-tax cash dollars from operations.

The other advantage of an asset sale to the Buyer is that liabilities, other than publicly recorded secured debts, do not convey with the assets.  Unknown people with slip and fall torts, potential employee liabilities, tax liabilities, many environmental liabilities, etc., which are not already subject to suit, or on public records, must find and sue the Seller as the Buyer has only bought the assets.  Upon selling, the Seller usually distributes all of the assets out of the corporation leaving no one with deep pockets to sue.

Let us give you a simple analogy on why buyers want to buy assets.  When you buy a car that has been in an accident, you don’t buy responsibility for the accident.  You just buy the car in its current condition.  In general, that is how asset sales work.

The recent tax changes (Tax Jobs and Cuts Act of 2017 changes taking effect in 2018) have made C corporations more advantageous for tax purposes than in the past.  But, from what we can tell for small businesses S corporations with pass through taxation usually will still have lower taxes than C corporations in asset stale transactions.  (But much less “penalty” than in the past).

In all cases, if you have a profitable small business that is structured as a C corporation, you should look into electing for S corporation treatment as soon as possible.  Some C corporation effects last up to five years after the election (this is current law, it has varied from 10 to 5 years at different times) but often the tax result can be vastly improved.  This situation requires competent tax advisors and valuation experts and goes beyond the scope of this blog post.

Personal Goodwill

Recent court cases have ruled that small business owners may own their Goodwill independent of the business.  If the owner was integral to obtaining and maintaining the work then some or all of the Goodwill generated at the time of the business sale may actually belong to the owner rather than to the business.  The beauty of this is that the Goodwill is taxed at the lower capital gain rate directly to the taxpayer.  It avoids the double taxation involved in the C corporation.  This must be structured as a separate agreement and has other technical requirements but, if you are operating a profitable and valuable C corporation, we highly recommend you look into the likelihood that you qualify.

Seller Consulting

Paying the Seller directly for consulting work after the sale is another tax-saving avenue when you have a C corporation as a seller.  While these fees are taxed as ordinary income, at least they are not double taxed.  When structured for real services rendered, this is a very acceptable solution for part of the problem, and is often a component of transactions for non-tax reasons.  In many businesses, the Seller is the only person who really knows how things work, and he or she must train the Buyer for a reasonable period after closing.

ESOPs

An ESOP is an Employee Stock Ownership Plan.  It allows the employees through a trust, not directly, to buy the company essentially through a tax advantaged leveraged buy-out.  The company takes out a loan based on its historic earnings.  The loan is then paid off from those future earnings.  The stock is owned by the employees trust essentially in conformance with their compensation.  This stock is actually owned in escrow and managed by the Trustee who can be the business owner.  ESOP’s are a complex retirement plan for the employees.  Recent rules have made ESOP’s more risky (particularly to the owner-seller/trustee) unless they are well run and managed.  Trustee’s are now required to protect the employee’s rights more stringently than early interpretations.  Again, this can be a great solution but it is complex.

More Thoughts on Deal Structure and Taxes

The sales price is what you pound your chest about when bragging to your friends.  But what really counts is the money you get to keep after paying everyone else including the IRS.  Therefore, take the last step of working back from the value to your likely after-tax proceeds.

In short, stock sales usually work best for Sellers.  Asset sales work best for Buyers but, because of liability issues, most small transactions will be structured as asset sales.

For most owners of small businesses, we recommend that you assume an asset sale.  An exception is when the company has valuable contracts that will not transfer to a new entity.  Sometimes, if the transaction is over two million dollars and has a sophisticated Buyer, you may be able to negotiate a stock sale.  Usually you split some of the tax savings (i.e. lower the price) between the Buyer and Seller and set up escrows to hold funds for unknown liabilities.

 


 

Clients choose Harvest Business Advisors for our accurate business valuations and our consistent ability to deliver the highest price in the smoothest sale transaction possible. Harvest provides business brokerage, business valuation, and business succession planning services. We have extensive experience in the information technology and professional services, manufacturing, distribution, and contracting fields. We maintain offices in Maryland, New Jersey and Virginia. Connect with us at info@harvestbusiness.com or 443.334.8000 to discuss selling your business, ordering a business valuation or buying a business.

How To Sell Your Business, Part Five — Generating Qualified Prospects for Your Business

by Greg Caruso,  CPA, CVA, Partner at Harvest Business Advisors

Once your business is listed, you’ll need to disseminate the information to the right people in order to sell the business. There are many sources of buyers, and we explore some of those here.

Trusted Advisors   Sometimes your attorney or accountant will have a likely Buyer.  Professional advisors are a good source for referring Buyers. Certainly, talk to that Buyer but at the same time keep in mind that your attorney or accountant is not a salesperson. You will have to do some of the work but it will be worth it. Your advisors are a great source of buyer referrals.

Teaser ads in major local newspapers  These can be very effective particularly for finding tradesmen, new Americans, and corporate managers.  A typical ad contains very little information but it is focused on getting the phone to ring.  Some examples are:

Pizza Shop Very profitable. Owner anxious to sell. 444-444-3333

Florist with Real Estate. Great location and established name 333-333-4444.

This can be effective for businesses larger than you may think.  Harvest Business Advisors sold a three million dollar business from a teaser ad.

Considering Selling Your Business? Please click here for a downloadable e-book, “ 10 Ways to Increase the Value of Your Business“.

Internet Listings  Primarily www.BizBuySell.com ,   www.bizquest.com, www.businessbroker.net and www.mergernetwork.com, and others.  This is effective for generating leads if the financial summaries fit the recommended valuation rules of thumb and it is the best source for corporate managers and corporate sales people.  You can also reach competitors who have set an automatic email for anything in their industry.    With Internet listings you need to list a little information about the business to indicate scale and industry and really focus on the numbers in order to generate calls.  The ratios must work in order for the phone to ring so this is an excellent reason not to overprice the business.  If necessary,  make aggressive adjustments in your cash flow and clearly point them out in your package in order to generate leads through this source.

 

Cold Calling and Direct Mail   If a competitor, private equity group, or other business is a likely Buyer, both cold calling and direct mail can generate responses.  While the response rates are generally low, again it only takes one Buyer.  You can greatly assist your broker by providing trade association lists and contact points to help them generate an inclusive list of prospects.  Research to identify potential buyers is a very important and time-consuming part of the work when this technique is appropriate.

 

Suppliers and Jobbers  In some industries, suppliers and other people who work regularly with many companies may know people interested in buying businesses.  Obviously, this does not work if maintaining confidentiality is important to you.  This is pervasive among liquor stores.

 

Brokerage  According to industry statistics, only 30% of Buyers purchase the type of business they first start calling on, and this number increases with smaller businesses.  This is one way brokers add value.  Brokers can take callers who decide they are not interested in the first business and move them to another businesses they have for sale.  A broker with many different businesses can move a prospect through many opportunities.  This is particularly important if your business is unlikely to generate phone calls directly either because of the business type or because of business conditions.

Intermediaries, Investment Bankers, and Merger and Acquisition Specialists are all brokers and advisors with different networks and abilities.  As the transactions get larger the advisory aspect of a broker relationship increases in value to the Seller.  It is likely that good advice will increase the final value by at least 15% above the original starting value.  It may not be worth paying a consulting fee on a $100,000 sale but for a ten million dollar business, that is a whole different ball game!

In general, brokers work with businesses up to about $1,500,000 in value; intermediaries handle businesses worth between $1,500,000 to $7,500,000; and investment bankers and merger and  acquisition specialists manage the $5,000,000 to $10,000,000 on up crowd.  Still, there is a lot of overlap between the groups at the edges.

Co-brokerage  Many brokers co-broker with other brokers they trust.  Since confidentiality is so important, a good broker will not send your confidential file to just anyone.  The prospect must be qualified first.  A good broker is always concerned with respecting and protecting the Seller’s confidentiality.  Every broker keeps a list of active Buyers which makes co-brokerage a useful technique particularly for smaller profitable businesses.

 This is part of a series of posts focused on “Selling Your Business”.

 

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