Value Drivers

Everyone exits his or her business at some point. While some business owners pass their companies down to family members, most sell their businesses to convert their values to cash for their retirements or other business ventures. Fortunately, for owners of independent destruction firms, there has been no shortage of buyers during the past few years. Industry consolidators such as Iron Mountain, Recall and Cintas have been very active, and more buyers have emerged to keep demand for well-run companies high.

The number of transactions reported would lead you to believe that every document destruction business is salable for a premium price. This is far from the truth. Buyers in this industry have a disciplined valuation process that considers many factors when deciding which companies to buy and what to pay for them.

Valuation theory is based on the principles of risk and reward. The reward of owning a destruction business is the cash flow the company provides to the owner. Risk is a measure of the possibility that something will happen to the individual business or to the industry that will reduce or eliminate cash flow in the future. The higher the profits that a company generates, the higher the value a buyer is willing to pay. The higher the risk those profits may decrease or be lost in the future, the less a buyer is willing to pay.

How does valuation theory evolve into a purchase price for a destruction business? The determination of value always begins with the cash flow of the company being sold. Cash flow is a firm’s profits that are removable in the form of cash. The seller’s reported cash flow is often not a true measure of the business’s actual cash flow potential. Accordingly, it is often necessary to adjust the reported cash flow to remove the impact of specific items reported by the seller that would not recur for the buyer. These adjustments are unique to each situation, but often include items such as owner’s compensation, personal expenses recorded in the business or one-time events that will not occur in the future.

Once the buyer identifies the true cash flow of the company, the buyer then considers how these cash flows can be enhanced post acquisition by assimilating the acquired firm into the buyer’s organization. These cash flow enhancement opportunities, commonly called "synergies," can be reductions of costs, increases in revenues or better use of assets. In theory, the buyer’s unique situation creates these synergies, and the seller should not reap the reward of additional purchase price in light of the buyer’s synergies. In practice, however, synergies do affect the seller’s determination of valuation and largely account for the wide variation of purchase prices offered from the bidders in any given transaction.

In summary, valuation theory rewards the best run businesses with the highest cash flow and easiest integration into the buyer’s organization with the highest purchase price.

With a basic understanding of valuation theory, it is easy to recognize how specific situations have a positive or negative impact on the value of the company upon a sale. These "value drivers" either affect current or future cash flow or affect the likelihood that those cash flows will continue.

One specific value driver is the type of equipment used by the company. Companies that use industry-standard shredding trucks, common-size consoles and automated, high-speed shredders and balers command higher purchase prices than businesses that have homegrown shredding trucks or slower manual-feed plant operations. It may appear to be more cost effective to assemble your own custom shredding truck or plant, but these "Frankenstein" creations are not usually efficient and do not integrate into the purchaser’s standardized operating procedures. Buyers will shy away from purchasing companies that rely on non-standard equipment or will substantially reduce the price they offer for such businesses.

Customer concentration is another value driver buyers consider. The old adage, "Never carry all your eggs in one basket," is true in business. Excessive exposure to a single client increases the risk of the buyer losing a significant portion of the business post acquisition. Increased risk results in lower valuation for the firm. Buyers will scrutinize situations where a single account represents more than 10 percent of a company’s total revenues.

Billing practices play a role in assessing risk to cash flow. Companies that bill by the pound of material collected or by the time spent shredding are considered to have riskier revenues than companies that bill by the container collected. Many buyers have had bad experiences where the revenues billed on a per-pound basis or time basis were based on "estimates," and the conversion to an actual measure post closing resulted in lower revenues.

The quality or recurring nature of a company’s revenues is a contributing factor to valuation. Revenues generated from recurring regularly scheduled accounts are considered more valuable than revenues from on-call accounts or periodic purge customers. On-call customers limit the acquirer’s ability to create route density, and purge revenues, though profitable, are not predictable or stable. Every company has a mix of recurring revenues and periodic purge revenues, but the higher the proportion of recurring revenues to purge services, the higher the perceived value to a buyer.

In valuation, size does matter. The third-party costs and organization effort buyers expend to perform due diligence, negotiate an asset purchase agreement and integrate the business is very similar whether the company is large or small. Naturally, buyers want to get the most "bang for the buck." Larger businesses also offer greater market penetration and often have capacity to accommodate the buyer’s national accounts in the acquired market. Companies with more than $1 million in annual revenues are preferred for an entrance into a new market, while those with more than $500,000 in annual revenues make nice additions to markets already served.

Geography also factors into value. You may have a highly profitable NAID (National Association for Information Destruction) AAA-certified shredding operation in Thief River Falls, Minn., but that market probably does not garner much interest from the national acquirers. Public buyers are building a national footprint to enable them to provide services to large multi-location corporate customers. The strategy has been to acquire companies in the top 50 most populated cities. While some buyers have largely completed their footprints, others are still seeking entrance into certain key markets. A seller whose business facilitates a buyer’s entrance into a strategic market will receive a premium valuation.

Buyers will consider each of these value drivers and others, but the extent that a buyer factors in any individual value driver differs from buyer to buyer.

The adage, "Beauty is in the eyes of the beholder," is true in business sales. We often receive offers for firms where the highest price offered is as much as 50 percent higher than the lowest price offered. The highest bidder on one destruction company may be the lowest bidder on the next company.

The only way to ensure you are receiving the highest price and the best terms is to present your business in an organized manner to each of the buyers. Our firm sells businesses using a controlled auction process that invites offers from each of the industry buyers and provides them organized and credible data on our clients’ value drivers. The process usually generates multiple offers for the company and allows the owner to select a buyer whose price and deal structure best meet the seller’s goals.

You only get to sell your company once. Be confident that you aren’t leaving money on the table when you do so. Present your business to each of the credible buyers in a manner that highlights your value drivers. You will sleep better knowing you received the best deal the market would bear for your company.