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Creating Value

Features - Business Operations

By concentrating on a number of proven business metrics, RIM business owners can build their businesses’ value despite the uncertain economy.

Chris Howard and Sean Slade February 4, 2013

Many factors influence the value of your business. Some you cannot control, such as the capital markets, interest rates, changing tax rates and competitors entering or exiting your market; but, other factors are within your influence. All affect what you can achieve when you sell your business. What should you be doing to bolster your odds of success?


Action Plan

By owning your own business, you bet on yourself, your company and the information management industry every day. Every day you don’t sell your business, you are effectively buying it, and the opportunity cost of this commitment of your time, energy and financial resources has to be evaluated against selling out.

How will you beat the other investments you might have made and increase or at least maintain the value of your business in the coming years? You could bury your head in the sand, maybe carry on as you have been, or you can accept that the operating environment is becoming more challenging and attack the new economic reality with a vengeance; learn the characteristics and metrics that influence the value of your business and align your business model to strengthen it around those metrics. Watching the outside operating environment is important, but don’t lose focus on what you can control within your business.

A wise business owner once said, “It is hard to teach judgment.” Another sage mentor said, “You can’t manage what you can’t measure.”

While teaching judgment may be elusive, what can be taught are those metrics that increase the value of a particular business. Ongoing measurement of those metrics is critical to managing value creation.


Operating Metrics

Business owners can use a number of operating metrics by which to manage the value creation of their records and information management (RIM) businesses.

Scale. In working with 200-plus businesses throughout the last 20-plus years, we have learned that margins for records management and confidential destruction businesses correlate with scale. Improved route density and real estate utilization, etc., imply that growth within a given market usually drives higher EBITDA (earnings before interest, taxation, depreciation and amortization) margins.

As a practical matter, business activities that support growth should be near the top of your value creation priority list. A business that is not growing is not treading water, as is often said. It is losing value, as lower growth commands lower exit multiples.

Driving growth means selling well, and effective selling means managing the sales pipeline and nurturing existing customer relationships. Regular pipeline management is the backbone of every effective sales and marketing effort. Whether your preference is to track net new accounts, penetration of existing ones, sales volume or some combination of the three, tracking leads through a sales funnel will measure sales effort and effectiveness and enable better management and results. In addition, regular contact with customers creates emotional switching costs and provides early notice of competitive pressures or service issues.

Getting close to your key customers through newsletters, lunches, tickets to games and customer appreciation days often generates referral business.

Revenue Quality. Revenue growth tends to inherently build value, assuming services are adequately priced and your cost structure is not unusually high, and recurring revenue leads to the best value creation. Monthly recurring revenue governed by contract and solid permanent removal fees is more valuable than episodic service revenue, and episodic service revenue is more valuable than occasional batch imaging projects. Similarly, recurring bin-tip revenue is more secure than episodic purges, and those episodic purges are more secure and, therefore, more valuable than one-time call-in destruction jobs.

Growing the right kind of revenue through sales incentives and tracking the percentage of each over time will better inform you and your sales team. Also, remember that expanding wallet share by penetrating existing customers may be less expensive than acquiring new accounts.

Contract Coverage Matters. At Waterfront Capital, we seldom see M&A (mergers and acquisition) clients with 100 percent of their customers covered by current and executed contracts. Contract coverage is where risk mitigation meets value creation. Limiting liability, creating an indemnification standard, automatic renewals, limiting customer cancellation rights and timing all serve to mitigate risk.

When we sell your business, a buyer’s first concern often is contract coverage and the terms of those contracts. The first thing we advise clients we consult with in improving their businesses for future sale is to get their contracts in order; collect all contracts and develop a spreadsheet or some other electronic accounting of all customers’ contract status. Catalogue start date, end date, whether signed or not (an unsigned contract is not a valid contract), assignment provisions, renewal provisions, escalators and permanent removal fees. After completing an inventory, then update stale or unsigned contracts and begin the process, which is sometimes lengthy, of obtaining contracts from uncontracted customers.

Measuring coverage and fixing contract terms is the easiest way to mitigate risk to your existing business and to add value in the event of a future sale. Also, keep a back up of your contracts off site. They are vital to your business.

Value considerations for confidential destruction businesses include route stops and density, service revenue per route per day and paper pricing. Most secure destruction businesses in the United States use mobile trucks that shred client materials on site. It is axiomatic that it is harder to manage off-premise workers than on-premise workers and, therefore, important to closely monitor field productivity by tons per day, stops per day, mileage per day, shred time per day, revenue per truck day, etc.

Paper Matters. While we emphatically do not advocate building your business around paper revenues, it is a fact of life that paper comprises a significant percentage of total revenue and a high percentage of EBITDA.

Employee malfeasance is not uncommon, and the variability of pricing is pretty high, so aggressively optimizing the value achieved for your paper is worth your attention. The merits of negative and positive sorting are specific to your circumstances and beyond the scope of this article. In general, we do not advocate excessive sorting, and most studies have demonstrated little benefit regarding sorting.

Document Destruction Equipment. New versus used? On site versus off site? Thankfully, the days when document destruction venders spent most of their time debating the finer points of competing equipment are long gone. Your primary value-add to your customers is providing them seamless service—the destruction of confidential information, not material handling. The buyer of your business likely won’t care very much if your equipment is suboptimal and, generally, they won’t pay much more for top-notch equipment.

We’re not advocating cutting corners on trucks or plant-based shredders; rather, we are pointing out that your revenue mix, density, growth, scale, pricing and customer concentration are more important considerations in the destruction space.

Shred trucks and plant-based shredders and related equipment are expensive assets, and high utilization should be a goal. Don’t be afraid to add a second shift before expanding processing capacity.

Records Management Fixed Costs. Records management companies have specific metrics that are important to understand and track. Real estate is an important expense that is large and largely fixed. Controlling real estate costs through thoughtful analysis and negotiation of any move or expansion is critical. The primary goal is not just reducing cost per square foot but also minimizing occupancy cost per carton (at capacity) and as a percentage of the company’s revenue.

If leasing your facility, control space long term but maintain flexibility with lease extensions. You also will want to control rate adjustments in the latter years. Maximizing density through prudent racking configuration and aisle width also can assist in lowering occupancy costs. Racking, like real estate, is expensive, and getting it right the first time provides a base for achieving higher margins from the outset. Higher density helps. Also remember, high quality, code-compliant rack, lights, sprinklers and aisle width are important to buyers in a sale.

Document Destruction Facility Considerations. Consider transportation logistics and windshield time in addition to direct costs when choosing a destruction facility location. Also consider workflow, ingress and egress for trucks, movement and storage of bales, etc. Other important building characteristics include size, clearance height, whether the structure is a single- or multi-tenant building, taxes, utilities and common area maintenance (CAM) costs, current rent, escalators, renewal and purchase options and expansion capability.

If the likely buyer of your destruction business would like to consolidate out of your facility, be cautious about longer leases. Unlike records management, switching costs are not high in destruction, so avoid burdening a buyer with unnecessary real estate.


Developing a Road Map to Success
You can’t go online and see the stock price of your enterprise (unless you work at Iron Mountain, that is), but that doesn’t mean its value doesn’t change frequently. Good business practices like those outlined above help to create intrinsic business value through varying market conditions and lessen business risk.

How can you learn more?

Read publications like SDB regularly, attend PRISM International and National Association for Information Destruction (NAID) conferences, reach out to other business owners who are not in direct competition with you, other industry experts and firms like ours for advice and to stay informed.

 

The authors are with Waterfront Capital, www.waterfrontcapital.com, a private investment banking firm providing a broad spectrum of financial advisory services to small and middle-market businesses. Chris Howard can be contacted at chrishoward@waterfrontcapital.com and Sean Slade can be contacted at seanslade@waterfrontcapital.com.

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