One of the most difficult discussions I have with business owners is when I tell them that my in-depth assessment indicates their business may not have “real” value. After years building a business that provides a great lifestyle, they just cannot believe that someone else would not readily pay to step into their shoes. In some cases, the owners have a formal appraisal or valuation that tells a different story from mine. They have read all the articles about other entrepreneurs selling their businesses for 8x to 10x multiples and living happily ever after. Am I crazy, or is there a real-world basis for my conclusion?
The key is that value is only “real” if it can be converted to cash in some form or fashion. It has to be transferable to someone else. Someone must be willing to pay you, the business owner, for the business you have built. Alternatively, the business must be able to continue to produce consistent positive cash flow to you after you leave for retirement or health reasons. Otherwise, the perceived value is not real.
The biggest problem is generally you. You have been the great driver behind the success. It is your innovative ideas and efforts that have seized opportunities. Your customers love you. They can count on you to resolve issues and ensure high touch service. Your employees love you. They are engaged and energized by you. They can count on you to stay in close contact and get into the details with them to help solve problems. You are the key to making the business machine run.
Here is the real test: Can someone else realistically step into your shoes and successfully maintain and grow the business as you have? Are your customer relationships, employee relationships and company know-how transferable to someone else? In many cases the answer is no. The business is dependent on you. You have done a super job, but your secret sauce is not structured to be transferable to someone else. It walks out the door every night.
70% to 80% of the value of a company does not rest in its financial statements, which measure tangible assets, but rather in its intangible assets (customer relationships, employee relationships, infrastructure, brand, know how, etc.). Appraisals and valuations tend to focus predominately on financial performance and theoretical value based upon various methods (capitalized earnings, discounted cash flow, and comparisons to companies of similar size that have actually been sold). Discounts or premiums are applied based upon the strength of your relative financial performance and the professional judgement of the valuation expert.
What valuations don’t capture is that 70% to 80% of small to mid-sized companies that go on the market each year don’t sell. Appraisers embrace the theory that every asset has a value that will attract a willing investor at some level. A deep evaluation of the transferability and value of the intangible assets, like what happens in a typical buyer due diligence process, is not a part of the appraisal process. Hence, valuations may not capture the probability that a transaction can really happen.
So, what should a business owner do? The key is that you need to build an institution, not just a business. An institution has a life of its own, not dependent on any one person. Critical processes, approaches, and know how are structured and documented in such a manner that others can step into the captain’s chair and keep the ship moving and growing.
This isn’t just about hiring more people and building structure. The keys include investing in mentoring, training and building internal capability so your employees can take on leadership roles, coupled with empowerment to solve problems and make decisions. Then, adding just enough structure to ensure your secret sauce becomes a living part of the institution.
Let me know what you think. Add comments or send questions. Contact me if you would like to understand how to protect and build the intangible value of your business.
Mike Hutson
Managing Director
Edge Financial Strategies, LLC.
[email protected]
www.EdgeFinancialStrategies.com
(317) 691-6811
Edge Financial Strategies, LLC. provides real world hands-on business experience to driving strategic growth for enduring success and solving the many hurdles that stand in the way.
Posted on