On a sunny Thursday in May, a business owner named Bill comes to a suburban office park north of Boston to find out how much he can expect to get for his company. As he told his appraisers when he first met with them the previous Friday, Bill has some decisions to make. He's 58. He recently had cardiac bypass surgery. His electrical-contracting business, which employs some 60 people and is known for its ability to handle tricky jobs -- such as rewiring a hospital without interrupting the power supply -- had annual revenue of \$23.2 million as recently as 2001 but has fallen off considerably since then. More to the point, Bill, who asked that his real name be withheld, would like to retire soon. But since neither his brother (a vice president), nor his son (a project manager), nor any of the other project managers have the skills or interest to run the company, he sees two options: He can bring in a new guy, appoint him, say, chief operating officer, and allow him to take over gradually. Or he can try to sell the company to an outside party. And that, of course, is why he's hired the appraisers -- to tell him what he might get for his life's work.

A solidly built man of average height, balding, with a neat gray mustache, Bill enters the offices of Axiom Valuation Solutions and takes a seat at a conference table. Stanley Feldman, chairman, and Roger Winsby, president, have prepared a 10-page large-print overview of Axiom's conclusions, but Bill turns right to the last two pages. Feldman and Winsby have broken down the valuation into two scenarios: the "Status Quo Scenario," which assumes that someone comes in, takes over, and runs the business pretty much the way Bill has; and the "Value Enhancement Scenario," which assumes that the person who comes in is able to build revenue back to where it was in 2001 and make significant reductions in costs. Feldman notices the change in Bill's expression as he spots the number for the Status Quo Scenario: \$1.5 million, plus the extra million in cash Bill has on the books.

"Less than you expected?" asks Winsby.

"Yes," says Bill.

Axiom charges \$2,000 for a valuation -- but for an additional hourly consulting fee that varies with the complexity of the case, Feldman and Winsby will also offer their advice. Today, Bill is paying extra to hear how he can maximize his company's value. Winsby gives the page-by-page analysis, while Feldman provides color commentary.

First, Winsby softens the blow of the lower valuation by explaining that the right type of buyer might be willing to pay more. That's because there's a difference between what he terms "fair market value" and "acquisition value." An independent person coming in to run the business much the way Bill has is likely to be willing to pay less than an "acquirer" -- a large company that's rolling up businesses like Bill's. The large company has a greater ability to reduce costs with economies of scale, and it has the financial wherewithal to pay more.

Still, the Income Statement Review tells a grim tale. In the firm's best year, 2001, it made \$511,000 in operating earnings on its \$23.2 million revenue. After 9/11, however, business slowed considerably: Revenue dipped to \$18.3 million in 2002, and last year was one of the firm's worst, with Bill eking out a \$100,000 profit on \$10.9 million in revenue. The situation would be even more worrisome, says Roger, if this were a manufacturing firm, with high fixed costs. But because it's a contract business, Bill has been able to expand and contract his work force as business comes and goes, and even when his revenue was sliced in half he was still able to make a small profit.

It is also encouraging that Axiom has determined that what has happened to Bill's business in the past three years is more or less in line with developments in the construction industry as a whole. While revenue for the industry dropped significantly in 2002 and stayed flat in 2003, Feldman and Winsby, using data from an economic and business forecasting service, have determined that construction-industry earnings are now likely to grow 12% annually. The question, they say, is how to get the firm back to the \$23 million level. Not surprisingly, the decline in revenue is a topic that Bill has given a great deal of thought: "People get stagnant," he says. "People get complacent."

Feldman suggests that Bill could bring in somebody new, someone to groom for the top spot. He could pay that person a modest salary but reward him with cash, equity in the company, or a combination based on the amount of business he or she brings in above and beyond the firm's current revenue. Feldman and Winsby estimate that Bill could pay a COO about \$100,000 a year, not including bonuses. That's about \$15,000 more than Bill had in mind, but Roger points out that Bill pays his project managers between \$60,000 and \$85,000, so \$100,000 would be appropriate to attract someone with the right skills. Or, Feldman suggests, he could start a new COO at \$85,000 and bring him up to \$100,000 for meeting goals, such as improving the way the company manages projects. It also might make sense to create different classes of stock, so that the new guy gets some ownership at first but not voting rights (to protect against unforeseen power struggles). Bill indicates that he's open to all of these suggestions.

The appraiser suggests that Bill bring in someone new to run the company.

As the appraisers continue to walk through the pluses and minuses, they note that one positive is the owner's discretionary-expense situation -- happily, Bill has not been mixing a lot of personal expenses into the business. Another plus is that Bill's segment of the construction industry, government industrial work, is a lot less cyclical, and thus less risky, than the commercial and residential sectors.

On the negative side, Winsby expresses concern that Bill's financial statements have not been audited. This takes Bill by surprise. He insists that there's been a misunderstanding and that in fact the statements have been audited for 20 years. Feldman asks if he's sure they're audited and not just reviewed. They're reviewed in June and audited in December, says Bill. Feldman and Winsby acknowledge the error and move on to another concern -- the company's high level of customer concentration. Once again, Bill has to disagree. It's the military, he says. The U.S. government. "We're dealing with the Navy, the Air Force, the Army, the Massachusetts Port Authority. They're not going out of business; they don't run out of money. It's not as high risk as when you have all your eggs in a private company." In the end, Feldman suggests that Axiom could lower the customer-concentration risk level in its calculations by listing each government agency that Bill deals with as a separate entity.

"You've got a couple of things going against you," says Winsby, moving on to some other concerns. "One is that you're a C corporation, so you're taxed twice." They'll get back to that. Winsby raises a related issue, one that's a little hard for Bill to grasp: the fact that his business is "100% equity-financed" -- that is, everything he spends comes from cash on the books and not from borrowing. He has a big line of credit for his business, but he's not using it.

It's good, says Winsby, but it's also a problem. Feldman explains that as it is now, each time Bill wants to take money for himself beyond his salary, he has to pay a 15% dividend tax. Instead, he could have his company take a loan from the bank using its line of credit and pay about 6.5% interest on it. That interest would be a corporate expense that reduces the income the company pays taxes on. Then he could personally take a loan from his company at an interest rate he determines. That would allow him to get a chunk of his personal wealth out of the company and into a diversified portfolio.

"I call that moving money from the left pocket to the right pocket," says Bill.

Yes, Feldman says, but it's not good to have so much cash -- \$1 million -- on the books. That's an asset he's not putting to work. He should only keep as much as he needs to run the business; the rest should be paid out. He can always lend money back to the company in a crunch.

Feldman points out that converting to an S corporation from a C corporation would save him big money on taxes. Owners of C corporations are taxed twice: once on the corporate earnings, and again whenever the earnings are distributed to the owners. S corporation owners are taxed only when the earnings are distributed.

It's not like Bill has never thought of this. The trouble is that if he makes the switch, he has to inform his bonding company -- bonding is much like insurance -- and if he does that at the wrong time, it's like poking into a hornet's nest. It seems that whenever Bill has considered converting to an S, it's been at times when the bonding companies have been struggling. Recently, Bill says, two major bonding companies have stopped writing construction bonds, so the people at Hartford, his bonding company, are getting nervous. His advisers have told him, "You don't want to go to Hartford and say, 'Bill's recuperating from angioplasty, he's thinking of retiring, the economy's tough, he doesn't have any big work on hand, and we're going to make a Subchapter S change. Oh, by the way, we still want an unrestricted bonding line of \$30 or \$40 million."

"But if you said we've just had a change in tax status..." says Feldman.

"Then they're going to look at everything else," responds Bill. "They'll say, 'What's his backlog? Why's he doing this? What's the economy like? What's our risk?"

They drop the subject and move on to what becomes the toughest part of the conversation. In addition to finding a way to bring revenue back to the 2001 level, Bill has to find ways to cut costs. That means reducing some of the generous benefits he's been giving his employees, including 100% health coverage and a pension plan funded entirely by the company at 8% of salary. Feldman and Winsby have calculated that bringing benefits in line with industry benchmarks would create \$450,000 in savings. "That's the reason I'm thinking about bringing somebody new in," says Bill. "Shuffle the deck. I'm a pussycat. I've had people here 20 years. I've gone to their weddings. I've gone to their divorces. I've gone to their christenings. How do you say to them, 'I'm going to cut your insurance'? They're family."

Even so, in 2002, when things started looking bleak, Bill laid off 30% to 40% of his rank and file. "Construction is construction," he says. "People turn over. They're transient people." But he decided not to lay off any managers or others who were part of a nucleus he considered key. He's well aware, however, that that decision came with a price. And he's already taken some small steps, such as announcing last year that there would be no wage increases. Gas allowances have been cut back as well. And where he offered a choice between an HMO and PPO health plan in the past (everyone took the PPO), he is now requiring employees who pick the PPO to pay the difference in cost. He's also exploring a 401(k)-style pension plan in which the company matches employee contributions.

Finally, they return to those last two pages: the Status Quo Scenario, where the business sells for just \$1.5 million, and the Value Enhancement Scenario. This number is far more encouraging. If Bill does everything Axiom proposes, Feldman and Winsby believe his contracting business can fetch a price of \$7.5 million.

At this point, Bill drops a bombshell. For the first time, he tells Feldman and Winsby that he actually had an offer from a utility back in 2001. Utilities had recently been deregulated, and this firm was setting up an infrastructure subsidiary. The executives found Bill's expertise in dealing with the military and government contracting very attractive. They offered him \$8 million. The deal was almost done; they were just haggling over Bill's life insurance policy and the excess cash and cleaning up a few details. "And then September 11 happened," says Bill. "And that's all she wrote."

Feldman points out that this was an example of a large company being willing to pay a premium -- the acquisition value Winsby had mentioned at the beginning of the meeting. Winsby adds that a huge utility's financing costs would be much lower. "They didn't need to finance," says Bill.

As the meeting ends, it's clear that Bill wants to take whatever steps he needs to get that higher valuation. Axiom is available for further consulting, helping Bill package his firm to potential buyers. Feldman and Winsby agree that they will make some adjustments considering that the financials have been audited and that different agencies of the U.S. government can be counted as more than one customer. A week later, Winsby reports that those adjustments resulted in bumping up the Status Quo Scenario figure to \$1.8 million, and the Value Enhancement Scenario figure to \$8.4 million.

And in that week, Bill has made a few decisions. He says he's going to try to find someone who can bring the revenue back to the \$20 million range. It won't be easy. Most of the people with the right experience to tackle the big projects are in Bill's position -- founders ready to retire. "Our firm is too large to be small and too small to be large. It's going to be hard to find the right person -- but not impossible," he says. Bill's using a headhunter to find an employee at a larger company who's interested in moving on and getting an equity stake. He says he'll be interviewing the first candidate the next day. i

### Sales Tips: Get those family members off the books!

1. Clean up your accounting books; make them as transparent as possible.
2. Clean up the physical appearance of your facilities, just as you would if you were selling your house.
3. You may have been, with your accountant's approval, running personal expenses through the business and writing them off. Stop.
4. Prepare a list of your customers. Include how long each has been a customer, how much each is likely to spend, the names of the key contacts at each place, and the nature of your relationship with them. Is the relationship easily transferred to a new owner or not?
5. Prepare a list of key suppliers. Who is easy to replace, who's more difficult?
6. Be able to show how much it costs to deliver a product or service to a client.
7. Have an employee manual that states rules of behavior and what is expected of employees.
8. Have a document that explains how all the machines in your business operate and who to contact for repairs if they break.
9. Get those family members who are nonessential off the books. Or at the very least, identify them.
10. Have your business valued every year. Be prepared for an unsolicited bid.
11. Be prepared to stay on in management for one to 10 years after the sale. The most crucial resource in your business is you.
12. Do all of this at least three years before you want to sell.

Jim Melloan wrote about the private space industry in Inc.'s June issue.