Dan Reiter, CFP®, CPA, CExP, CVGA
There are several approaches to valuing a privately held business, but at their core, most methods to measure business value are based upon two elements of value: cash flow and risk.
A company’s value drivers are those characteristics that increase the value of a business by reducing the risk element. Most business owners focus heavily on growth in top-line revenue or cash flow, but to their detriment, they ignore other key value drivers that buyers seek.
The problem is that a focus on growth alone can lead to more problems and increased risk. Have you ever encountered a point in your business where sales or revenue were growing successfully, but more headaches seemed to result? You are certainly not alone—this is a common symptom of a company that continues to scale up without sufficient focus on building infrastructure to support it.
However, experienced buyers are very skilled at sniffing out such issues during the due diligence process.
To build such infrastructure, our financial planning firm in Kansas City, MO, measures quality and makes recommendations to owners. These recommendations systematically and methodically focus on eight foundational areas of the owner’s business to increase value and attractiveness to buyers:
Planning
Leadership
People
Operations
Sales
Marketing
Finance
Legal
No matter what exit path you seek—insider or family transfer, third-party sale, or something else—you and your business can benefit from an intentional focus on the above areas.
Some of the key benefits include:
Improved preparedness of your business to be transferred at a higher value
More time before you leave the business
Flexibility in transfer options to better suit your “values based” goals.
Let’s pretend you found yourself stranded on a deserted island for 30 days, with no access to the outside world and absolutely no way to contact anyone in your business. What would result? Would the company adapt and continue? Or would it quickly hit a wall and be unable to function?
If the answer is the latter, you likely have a transferability problem that is dramatically impacting the value of your company. The bright side, I suppose, is that you’re in good company: Only about 20% of businesses that go to market actually sell, and even the success rate of 30% in transferring a family business is not significantly better.[1]
Owners of best-in-class businesses understand that their best creation is not the products or services being offered—it’s the company itself. Jim Collins, in his best-selling book Built to Last, eloquently puts this as the difference between “time telling” and “clock building.”
Collins describes a person with an uncanny ability to tell exactly what time it is—down to the nanosecond. This would be quite a remarkable skill, assuming the person who can tell the time is still around! The point is, though, would it not be much more useful to have an accurate clock?
Many companies operate with great time tellers at the helm. However, the “clock” (the business) is often in poor working condition. A focus on working on the company rather than in the company is a clock-building exercise. This exercise makes the business much easier to transfer to the next generation of owners and significantly improves company value in the process.
Remember—business value measurements consider risk as a critical factor. If the risk of revenue ending when you do is high, savvy buyers will heavily discount the associated value of that revenue.
Much of the nature of focusing on the eight foundational areas that drive value is concentrated on building strong systems in the company—in other words, systems that can operate without you doing them!
Perhaps the most common objection to the business planning process we hear from owners is that they do not have the time to dedicate to it. Meanwhile, they are overburdened and stretched thin by the tremendous demands that come with scaling a successful company. Since most major business functions often rely on their direct involvement and oversight, time is a scarce luxury.
My answer is always the same: You cannot afford not to spend the time working on the business. Companies can never outgrow infrastructure issues. If you do not stop today to address the right issues, the result is almost always an eventual reckoning. It usually comes in the form of owner burnout, company closure, or a sale at a discount to the price that could have been received with proper planning.
The solution is an investment of scarce time dedicated to “clock building.” While, initially, owners may feel they have less margin in their time in the early stages of planning, most find they quickly reap the benefits many times over as the business learns to begin “telling time” on its own.
If your main job is to tell time and you have a clock that does it for you, what else could you do with your time?
Finally, another objection I often hear is that others in the company just can’t do it the same way the owner can! While this might be true (or it might not be), you cannot know unless you learn to, as one business author puts it, “let go of the vine.”[2]
Moreover, a company that relies on you to perform the key functions has minimal to no value. So, what do you have to lose?
A focus on value drivers increases flexibility because it puts owners in the driver’s seat. With a more valuable company, owners increase the options of successors available to them.
Even if your plan is to not maximize value with a third-party sale, it’s wise to focus on keeping options open. This is true even when you plan to transfer to a key employee, insider, or family member. Why? As noted above, the success rate even on family businesses transfers is less than half!
For many owners, the most important elements of a transfer are not financial at all. For example, it may be important to maintain a certain culture, “way” of developing a product or providing a service, or maintaining jobs for all the key employees. Often, this results in an owner accepting an offer that is not the highest one received.
One important fact to remember is that you can always accept a lower offer that is a better fit or match with your goals. However, you cannot compel a higher offer if your company does not command the price.
Understanding how much you need to sell your business for should provide the minimum acceptable offer. By focusing on creating maximum value, you maximize the probability of multiple offers above this threshold. Ultimately, this allows you to choose the offer that best fits all your exit goals, not just those that are financial.
Discuss your situation with a financial advisor with experience in working with business owners. Schedule a 30-minute discovery call today.
[1] Snider, Christopher. Walking to Destiny. Think Tank Publishing House. 2016.
[2] Wickman, Gino. Traction. BenBella Books, Inc. 2011.