What makes a business valuable to potential buyers? What factors increase a business’s valuation? These questions are at the core of transitional planning. Tangible assets, the physical property the business owns, is only one factor of what makes a company valuable. This is not even the most important factor. Intellectual capital is the intangible value of a business, or, in other words, assets that cannot be touched or sold but directly affect how profitably the company operates.
The Exit Planning Institute estimates that up to 80% of a business’s value comes from its intangible assets. This intangible capital can be further subdivided into four categories – what EPI refers to as “the 4 Cs.”
The 4 Cs
There are four types of intangible assets:
- Human capital- This is what your employees bring to your business, including their creativity, knowledge, abilities, work ethic, and drive. If your business has a worker who everyone thinks is irreplaceable, this is valuable human capital. This includes you – the business’s owner. Any buyer will want an assurance that this type of employee will continue on with the company after a sale. As such, a business that is owner dependent will command a lower price on the market because buyers will sense that the business will not be as profitable when the owner exits.
- Structural capital- Structural capital is the underlying skeleton of the company – how it’s organized and the systems or processes it has in place for accomplishing tasks. A company with established procedures and systems can more easily survive the loss of several employees – even good ones. Structural capital also includes what the company has developed over time to improve its ability to compete. This includes data, intellectual property, trade secrets, and proprietary software.
- Customer capital- Does your business have a large and diverse customer base? This is customer capital. If a business has only one or two customers and loses one, how profitable will it continue to be? If your company services only one industry sector, the overall health of that sector will factor into how robust your customer capital is. In Michigan, for example, strong companies with great human and structural capital still suffered if their products or services were too tied to output of the failing automotive sector.
- Social capital- This type of capital is the relationships that the company has built up over time with its customers and includes goodwill and brand loyalty. Public relations factor in here. Things like employees involved in scandals or crimes, poor online ratings, or a major gaffe on social media can cause social capital to plummet and customers to flee.
From these examples you can see how not developing a company’s intellectual capital in these four areas will affect valuation. Savvy buyers will note a company’s vulnerability and decide whether they think a company can survive a transition of ownership and continue to thrive afterward. To build intellectual capital, a business owner must evaluate his company in the above four areas. It’s as simple as identifying vulnerable areas and putting effort into developing them so that they become less fragile. However, building intellectual capital takes time and focus, often years of setting and meeting individual goals.
How Do You Benchmark Intellectual Capital?
Again, each type of intellectual capital must be assessed for vulnerability. At Prometis Partners we help our clients set specific goals and design plans to meet those goals. If a company has only a handful of customers, improving customer capital will mean pursuing other customers and developing relationships with them. It’s not as simple as rounding up more customers and adding them to a spreadsheet, though. Buyers will want to know how much business the company does with each customer, how often, and if that customer pays his bills.
Increasing human capital will mean creating layers of expertise in a business by either hiring more talent or further developing the talent already available. The goal would be to make sure that no area of a business is dependent on one specific employee remaining with the company.
Other types of capital, like social capital, may be harder to assess. That’s why it’s good to get an objective assessment of your company’s intellectual capital well ahead of when you think you will want to retire or otherwise exit the business. There are many strategies for improving all of the 4 Cs, but most of them cannot be accomplished overnight.
For more information or to answer any questions you may have, contact Vincent at (616) 622-3070 or by email at firstname.lastname@example.org for your initial consultation.