Businesses can be strong income engines or they can be valuable assets in their own right.
Sometimes they can be both. We emphasize that business owners have two businesses: the commercial business and the business of the family, which we call the family business. The ultimate goal should be to build a strong family business.
We work with business owners to identify and reduce hidden risks, to stop the silent leakage of value from the business, to build strong structures and to minimize the disruption and damages that can result from transition.
Step One: Perspective
Business Valuation is in the Eye of the Beholder
The value of a business is in the eye of the beholder.
Who is the “beholder”? It is never the business owner.
- At a sale, it is the buyer.
- At a loan, it is the lender.
- With hiring senior executives, it is the employee.
- With risk, it is the insurer.
You need to be armed with the knowledge of how your “beholder” will value your business.
A business valuation is a critical tool and a worthwhile investment.
Not only does it provide an estimation of value, but it provides a list of the weaknesses that the business has (in the eye of the beholder). That list helps create a roadmap for change that should increase the value of the business.
Step Two: Understanding Current Value Leads to Maximum Value at Sale
Any business owner who wants to build value in their business must first uncover what the present value of their business is. We say “uncover” because it is a process of discovery rather than the product of a simple formula.
We conduct a pre-due diligence audit to find risks and problems and help owners eliminate them to avoid surprises about business valuation.
Buyers will engage in their own extensive due diligence process to reduce the price. They are uncovering risks or problems in the business that will reduce the value.
It is important for the owner to uncover those risks and problems and fix them long before they get ready to sell.
Step Three: Intangible Business Value Drivers
Next, we focus on three areas that have an impact on intangible value drivers: Risk, Leakage, and Transitions.
Our process uncovers and reduces hidden risks in a business, identifies and prevents business leakage, and minimizes the loss of value that can occur during transition.
Risk is a key component of value. The greater the risk, the lower the value. If you lower the risk, the value will rise.
Examples of Risk:
If 60 percent of sales is dependent on one customer, there is a high degree of risk in losing that customer, and that risk lowers the value of the business.
Failure to have Employees sign NDAs or confidentiality agreements in a technology business, can pose another risk. If your business depends on the knowledge and your company does not have strong IP and trade secret protection in place, then the loss of key employees will reduce its value.
Leakage. Keeping and protecting your wealth is as important as building it. You need as much focus on plugging holes as on building wealth.
Leakage occurs when something of value trickles away. It is often unnoticed.
Where leakage exists, the business owner is faced with trying to fill a bucket covered in holes so that the value cannot rise.
Examples of Leakage:
The business do-over: the process of fixing defective products or services that were delivered to customers, which silently reduces profits.
The continual turnover of employees which results in a recurrent and repetitive less productive training cycle.
Transition. This is an area that creates a high degree of risk and can threaten to substantially reduce value. The most dangerous time in any business is a time of transition.
We use advanced planning to reduce or remove the dangers associated with events of transition that happen to every business and every business owner.
Examples of Transition Threat:
The unplanned departure of an owner will always have an impact on value.
What happens if a 50 percent owner wants to leave the business and no Buy-Sell agreement exists? It’s easy for the partners to disagree on the value and on how and over what time the retiring partner should be paid.
Whether it is the security of buy sell agreements, or exit and succession plans planning makes all the difference to valuation when the event you never want to think about happening does happen.
We work with business owners to uncover and remove risks.
Attention to areas such as developing retention programs to keep key employees in place lowers risk. Strategies such as phantom stock and other deferred compensation plans, and attractive salary and benefit packages are essential.
We help business owners identify and plug the holes in their business where value is leaking away.
Potential areas of leakage control include protecting IP and assets, retaining employees, legal and tax compliance, customer service, minimizing defective products or services, managing litigation, managing insurance.
On a basic level, business value often is thought of as EBITDA multiplied by a number called a multiple. EBITDA times a multiple, simple right? Well yes and no. It’s a simple way to calculate value, though not always accurate. While determining what EBITDA is can be pretty straight forward, knowing which multiple to use is far more difficult.
Other valuation methods exist, but for illustrative purposes let’s use the most common:
Multiples can have a wide range: for example, if a business had an EBITDA of $250,000 and was subject to a multiple range of between 1 and 3, the value might be as low as $250,000 or as high as $750,000. That is a pretty big spread in value and one of the major value differentiators.
Business Value = EBITDA x EBITDA Multiple
As EBITDA increases, multiples can increase. It is the combination of these two factors that drives business value and the multiple actually has the largest impact.