The Importance of Back-Office on Company Value
If you're considering taking an investment or preparing for an acquisition, your company's potential valuation is one of the most critical aspects of the deal. And even if you don't have any current plans for investment or liquidity, putting modern business practices in place to solidify your future value is a good strategy.
One often-overlooked factor in your company's value is how you run your back-office. In many cases, getting it right may not discretely increase your company's value, but the improved visibility and efficiency enabled by a high-performing back-office definitely adds significant value to your company over time and ultimately drives a higher value. One thing; however, is certain - getting it wrong can do a lot of damage. Inadequate back-office practices over time will likely hurt your value, and can oftentimes stall or even kill a deal altogether.
So why is your back-office strategy so important to company valuation?.
First, what is "back office?"
First things first: what do I mean by the back office? The dictionary defines it as "an office or center in which the administrative work of a business is carried out, as opposed to its dealings with customers".
Generally, back-office refers to the functions that directly support and enable the business operations. This includes departments like:
Finance
Accounting
Reporting
Billing
HR
FP&A
Legal
Your business can't operate without these functions, and so in many ways, the back office forms the backbone of your company.
Why is back-office so crucial to your company's value?
Let’s quickly acknowledge that a company's core value is its differentiating capabilities that live within the product and the customer experience. The investment in the back-office should reflect that it’s not a differentiating capability, but the budget allocation needs to be sufficient to allow the rest of the company to freely thrive. Having an elite HR or legal team isn't going to drive top-line, but customers want to buy from well-run companies with who they have great overall interactions, and in that way, the back office does significantly impact the external customer experience.
And internally, well-run back-office functions support how effectively and accurately your business operates, which can drastically impact your valuation. Sloppy or rudimentary back-office practices can lead to unnecessary risk, compliance gaps, low employee morale, and/or untrustworthy data and financials resulting in a lower valuation, more escrow, more contingent payments, longer diligence periods, or increased indemnity requirements in a transaction, for example.
In the worst cases, a poorly run back-office can kill a deal altogether. Even if a buyer or investor loves your business, once they come across too many back-office red flags, they might decide to let the deal go or reduce the valuation so low that you have to walk away. In many of these cases, this is a strategic public buyer who is willing to pay the highest premium, but as an SEC-registered company cannot accept the risk.
Those problems can come in quite a few shapes and sizes across finance, billing, legal, and HR. Here are some examples:
Financial
Not having audited financials can prevent a deal from closing, while having an audit can accelerate the timeline. There are a lot of small publicly traded companies who are potential buyers, and not having historically audited financial statements can be particularly problematic in a software deal.
Not keeping high-quality monthly financials and clearly understanding micro-business trends can result in difficulties projecting the balance sheet, which can result in an unexpected material post-closing purchase price adjustment.
Not having clear model assumptions supported by key business drivers and trends to back up growth projections you provide will make it easy for a buyer to suggest they cannot rely on the forecast to justify a price reduction or why they ‘need to do more work’.
Recording revenue on a cash instead of accrual basis will always create additional diligence time, slow down the process, and can result in a buyer misunderstanding customer trends and you needing to disclose sensitive customer and contract data you otherwise wouldn’t provide, at least this early in the process.
Not presenting EBITDA and considering how potential historical non-recurring or non-cash items will impact a buyer's valuation model.
Not charging/filing/remitting sales taxes.
Not considering state nexus issues on income and sales taxes.
Not filing returns (or not filing them timely can delay timelines).
Contractual/Legal
Undocumented or poorly documented third-party transactions.
Not filing trademarks or patents when appropriate, or keeping them current as they come up for renewals.
Customer contracts that are not freely transferrable/assignable, or require approval from customers.
Customer contracts with unique and inconsistent terms.
Missing, or unexecuted customer contracts.
Exclusive licenses have been granted to certain customers or 3rd parties that you weren’t aware of.
Maintaining customer credit information in a non-PCI compliant environment.
Not having historical insurance coverages in place that effectively limit claims that have not yet been made/reported, including D&O, cyber-liability, E&O, etc.
Human resources
Employee equity grants or bonuses that are verbal or haven't been properly documented.
No double-trigger in employee equity agreements, causing the buyer to negotiate new deals pre-close/concern that key employees will not stay.
Required annual filings not complete (1099s, benefit plan requirements).
Lack of compliance with employment rules (FLSA, leave, ADA, sick pay, maternity, OSHA complaints, etc.).
Incorrect independent contractor vs. W2 employee classification, or not considering K1 vs. W2 employee in an LLC.
Incorrect exempt and non-exempt status in your employee base.
This list isn't meant to scare you. These are things you can and should easily put in place if you haven’t, or that you have time to correct if they are already off track.
How to make sure your back office doesn't de-rail your deal or lower your company's valuation
There are several broad initiatives that, when put into place, will build trust with potential investors and buyers, streamline the due diligence process, and boost your business' potential value.
1. Be intentional about your process and your systems.
It's essential to have documented processes and workflows, and well-implemented and utilized systems in place, and well-defined KPIs.
It's a best practice to document the business's day-to-day operations and the supporting workflows—from how back-office tools are used and applied, to how & where specific business metrics are tracked, to how financial procedures are executed and monitored. Likewise, policies and procedures should be live documents and available to all relevant team members.
Use the concept of "source of truth" to ensure you are consistent in how data is stored, tracked, and reported.
"Single source of truth (SSOT) is a concept used to ensure that everyone in an organization bases business decisions on the same data."
Always have a source of truth for the metrics and data used to run your business. Everyone in the company, or at least within the back office & leadership teams, needs to understand the source of truth for how data is tracked, organized, and measured.
Having documentation, written policies, and source of truth on all business data it helps you provide data and insights into your business confidently and allows you to respond to due diligence requests quickly & accurately. It takes a 5-minute conversation, for example, to define you should calculate customer retention and churn and where the information should reside. If you never define it, you may find down the road as you grow that different functions are measuring it in different ways, and different systems have different information.
2. Build cross-team collaboration into the system.
Fostering healthy communication, collaboration, and openness within your leadership team goes a long way in general. But it's also helpful in adding value to your company in the eyes of investors and buyers.
For example, in many companies, the CEO and CFO sit down, crank out a budget, and pass it off to everyone else. But if you instead involve all the relevant department heads in creating and managing their budgets, you have built consensus around a measurable goal, you have empowered your team to make important decisions, and ultimately are creating a team that's valuable in the eyes of some of your investors & potential buyers. Build a capable leadership team with a holistic perspective on the broader business, not just their areas – a team that actively participates in running the business, managing budgets, setting & reporting on KPIs, etc.
3. Get the right help in your corner.
Whether you bring the expertise in-house, outsource, or use a hybrid approach, you need experienced help. At a minimum, work with legal, accounting, and human resources experts familiar with your industry and type of business. The right people & the right advisors can provide proactive guidance on what's needed to run your business in a way that limits risk & gaps across the back office.
4. Don't wait too long.
One of the biggest mistakes in avoiding back-office missteps is waiting too long to get started. It's always much easier to build the proper infrastructure early when your company is still small, versus trying to reorganize and plug holes later. Going back to cross T's and dot I's is inefficient and can be laborious, distracting you from growing the business. A huge ecosystem of high-quality and cost-effective tools exist today that can help you increase automation and stay organized across areas you otherwise might ignore until it’s too late. Many of these tools can really make your life easier and your day to day less complex – take the time to do your research, implement, and learn how to use these tools the right way. Then, set them on auto-pilot.
It's never too late to start, but the earlier the better. The best time to start is right now.
No, it doesn't have to be perfect.
This may all seem overwhelming, but it's not as complicated as it appears. Yes, you need to be operating your business with sound fundamentals, risk management, legal & regulatory compliance, documented operating processes, and strong financial oversight. But that's just good business anyway, and an essential underpinning to creating a company that can scale.