Why Metrics Matter
Many business owners wonder why buyers insist on reviewing operating data as a part of their due diligence efforts. They protest that the metrics are immaterial, because their effects are already baked into the financial statements, which the buyers have analyzed ad nauseam. Sellers are usually comfortable providing the more administrative due diligence items, such as contracts and the tax returns, but struggle to understand why they should supply data on their companies’ operating activities.
Key Performance Indicators
Isn’t it true that the financial statements incorporate the impact of the operating metrics? If so, why are the key performance indicators critical to the buyer’s analysis? These “KPI” are important, because their trends can be the best indication of a company’s future prospects, and because they are the main inputs for calculating synergies (strategic buyers) and validating investment theses (financial buyers).
A simple example involves a manufacturing company that is performing well financially, but has seen its quoting activity fall significantly in recent months. Everything else equal, it would be logical to assume that the company will post reduced revenue and profits in the near future, but this potentiality would not be evident in the financial statements.
Another basic example relates to this same company’s scrap rates, changeover times and raw material prices. For buyers who either have similar operations or are familiar with industry benchmarks, these KPI indicate whether there is an opportunity for improvement, which, for strategic buyers, could also apply to their existing businesses. In addition, these data are integral to calculating, for instance, the benefits of facility specializations and rationalizations.
What If The Data Do Not Exist?
The smaller the business, the more likely the owners do not track all the information that sophisticated buyers want to review. But this issue may lead to even more exaggerated problems with novice buyers who, lacking experience, are unable to prioritize their due diligence needs and end up asking for everything.
We have encountered many business owners who managed their companies with an intuitive feel and had no way of producing historical operating data. In these cases, it may be necessary to reduce risk by lowering purchase price, increasing the amount of seller financing or seeking more robust representations and warranties.
In most cases, however, there is usually a way to create a time series of information about a very short list of the most important metrics. As a result, we recommend that buyers focus on the KPI that are critical to their analyses and then work with the owners to develop actual or proxy data for these fundamental items. If possible, sellers would benefit from spending time in advance of taking their companies to market in order to generate basic KPI data.
Bootstrap Capital
If you are aware of business owners who would like to sell their companies, but lack straightforward operating data, please consider introducing them to Bootstrap Capital. We have dealt with these due diligence issues as both sellers of the businesses we built and as buyers of other entrepreneurs’ companies. As a result, we are keenly in tune with the issues business leaders face when they decide to sell their companies, as well as many other nuances of transacting in the lower middle market. In situations where a business owner is working through these issues, Bootstrap Capital is, at a minimum, a patient counterparty and, even better, frequently a constructive partner in helping him or her through the process.