Adam. J. Fein: Increasing business valuation with technology

Many business owners do not pay enough attention to the impact of technology on the value of their business.  Is your information technology system an asset or a liability in this environment?  In this column, I explore the connection between business value and technology in three situations—distributors planning a sale to a financial buyer, distributors contemplating strategic acquisition of other distribution companies, and distributors planning to sell to another distributor. 

A financial buyer purchases a private distributor as an investment and therefore looks at the potential return from owning the business for four to six years.  They are being attracted by the ongoing need for wholesale distribution to end-markets insulated from global competition, such as facilities maintenance, construction, or health care services.  

Financial buyers today are displaying a far greater ability and willingness to pay premium prices for leading distribution companies.  In many of 2005’s transactions, they paid higher purchase prices and purchase price multiples than strategic buyers such as large distributors.  

In general, financial buyers are looking for well run wholesaler-distributors that provide value-added services, have solid management teams, capable information technology (IT) systems, thorough training programs, defensible market positions, stable cash flows, and multiple growth opportunities (i.e., both organic and via acquisitions).  They also expect the current operating management team to remain and grow the business.  A distributor at the end of its lifecycle is only worth the value of its assets.

The financial return to a buyer is strongly influenced by the level of value-adding technology already at work and the technological compatibility with other systems.  For example, a financial buyer views older IT systems with “homegrown” part numbers and proprietary standards to be liabilities.  These buyers correctly recognize that any further growth will require investments in a new infrastructure.  Your company should purchase a modern, scalable IT system at least two years ahead of any selling date to be viewed as an attractive acquisition target by a financial buyer. 

On the other hand, many distributors are considering strategic acquisitions in today’s active market.  Technology influences the financial return to an acquiring company by affecting the quality and speed of post-acquisition business integration.  A growth-oriented IT infrastructure must support fast visibility and/or rapid integration of an acquired company’s customer records, orders, inventory, warehouse operations, transportation and finances.  

These essential attributes are found in most enterprise systems today.  Obviously, a major investment in information technology will hurt your company’s cash flow.  However, this short-term pain will be counterbalanced by building a more solid platform for acquisitions if your company is a prospective buyer.  

Finally, a company contemplating a transaction with a strategic buyer can make an asset and liability evaluation of the IT system from the perspective of a potential buyer. Potential sellers should have a modern, compatible system as a goal of the IT system. Your company’s IT system will be an asset if post-purchase integration becomes easier for the buyer.  

For example, technology is likely to be an asset if your company has a relatively new system, uses clean vendor and customer information, and contains inventory records with up-to-date part numbers.  Alternatively, an older proprietary IT infrastructure becomes a liability and decreases the value of your business if integration is harder for a buyer accustomed to rapid, standardized integration.  

Forward-looking business owners should recognize the way in which an IT system can alter the value of your business, both positively and negatively.  A strategic view of technology investments will help achieve maximum business valuation as either a buyer or seller.