You’ve devoted a significant portion of your life to working incredibly hard to build your business. Whether you’re planning on retiring in the near future or simply want to sell to another entity and remain involved in a more limited capacity, having a plan in place sooner rather than later is one of the best ways to avoid potential issues down the line.
During this time, it’s natural to want to accelerate the value of your business as much as possible – thus allowing you to see the maximum return for everything you’ve put so much time and effort into up to this point. But one of the most important things to keep in mind is that growing your organization’s value and growing your revenue, while similar, are not the same thing and should not be treated as such.
Business value is exactly what it sounds like – the total worth of all tangible and intangible elements related to your organization. Tangible elements may include equity and monetary assets, while intangible elements may be related to the overall impression of your brand and the goodwill you’ve built with your target audience. Revenue, on the other hand, refers to the total amount of income that you’re generating by selling your products and services before considering your expenses.
While growing your revenue is generally seen as a positive sign towards the future health and success of your business, it doesn’t necessarily immediately translate to an equal impact on business value, as there may still be certain expenses that are severely limiting your bottom line.
Therefore, if you want to take meaningful steps to grow the value of your business prior to your exit while also securing your own financial future, there are a number of critical factors you’ll need to keep at the forefront of your mind.
Why Business Value Matters
To get a better picture of why it’s so important to pay attention to more than just your revenue, consider the following example.
Business Owner A may determine that he would like to exit his business in five years with a post-exit annual income of $250,000. After consulting with his advisors, he learns that he needs to increase the value of his business from $3 million to $4.5 million in order to meet that goal and that growing cash flow (or EBITDA) by $100,000 a year could make that happen.
This then becomes a concrete goal on the owner’s exit planning timeline and is a benchmark for the owner and his advisors to keep their eye on.
Depending on the expenses of the organization, simply increasing business revenue may not be enough to hit this particular target. Remember that revenue is just one of the many factors that can help you determine the true business value of your organization. Others include but are certainly not limited factors such as:
- Market share.
- Brand recognition.
- Customer loyalty and retention.
- Customer satisfaction and more.
All of these factors demonstrate why it’s crucial to understand that revenue alone doesn’t equal profit or value. It’s entirely possible for a business to generate $1 billion per year in revenue, but also rack up expenses in excess of that number. When expenditure is that high, the business wouldn’t be valued at $1 billion for the reasons outlined above.
To truly begin to get a sense of your business’s true value, you must first start by assessing your organization’s value drivers to determine how robust they are.
Value Drivers: An Overview
Within your organization, value drivers are entities that increase the value of your product or service by improving their perception and providing your business with a competitive advantage.
Value drivers can come in many forms, such as cutting-edge technology, brand recognition, or even just an ever-increasing number of satisfied customers. These value drivers are what will draw interest in your business, which is pivotal when the time comes for it to be put up for sale. They often create sustainable, long-term cash flow, which is why they’re a strong indicator of not only how successful your business is today, but how well it may fare moving forward as well.
Value drivers include but are not limited to:
- Stable and capable management that will remain in place after a sale.
- A large and diversified customer base.
- Brand recognition.
- Good cash flow.
Installing strong value drivers is a crucial element of the value acceleration and business transition process. When value drivers are strong and obvious, the business’ value and curb appeal to buyers will increase, thus making it both more valuable and easier to sell.
While business value can be built without utilizing a strategy targeting specific value drivers, it will likely take longer and have less obvious results. When an owner has a timeline to follow to meet a specific transition date, there’s no time to waste.
Value to the Owner versus Transferrable Value
Throughout the valuation process, it’s equally important to understand that the value your business has to you, its founder and owner, is not necessarily equal to its transferrable value – meaning the value in the eyes of prospective buyers.
There are plenty of reasons why a business is important to an owner, including:
- Personal History – For an owner who built a business from the ground up, he or she will naturally associate their life and key milestones of their life with their business. It’s so integral to their life that they may have a hard time separating themselves from it. This can also be the case with a family business, especially when the organization’s history is intertwined with family history and fortune.
- Power and Prestige – Many owners come to appreciate being in a position to make things happen. This can be true both in terms of the business and the impact it makes on its communities. Their sense of self may depend on being a person of power and influence, and, as such, they may dread selling and leaving this position.
- Money – While the goal of any business exit is ensuring financial security for the owner going forward, many owners anticipate a drop in their standard of living when they transition to a new phase of life. In order to maintain a comfortable lifestyle, they may feel they have to keep working at some capacity. The business, in turn, represents personal prosperity and comfort to them.
- Unique Gifts or Talents – Many businesses run as well as they do because their owners are unique. They may be very charismatic, great at networking and pulling in customers, or tremendously talented in other ways. For this type of owner, work represents an opportunity to shine. Unfortunately, in terms of the business’ value to prospective buyers, a one-of-a-kind owner represents a real risk to the organization’s operation when that owner exits.
For many owners, the opportunity to build and run their own business is priceless. This view of value, while important to the owner, isn’t helpful when it comes time to sell.
That’s why transferable value is so hugely essential to the transition process. Transferable value takes a look at the overall value of your organization when you will no longer be a part of the business.
When that day comes, how well will your business run? What kind of profit can it expect to make minus your talent and leadership skills? These are a few of the many, many questions that potential buyers will ask, and you need to be adequately prepared to answer them.
Primarily, people want to buy businesses that are both A) consistently profitable, and B) low risk. They want to see solid and improving cash flow. They look for organizations that have strategies in place for scalable growth. A large and diversified customer base is a huge asset, for example. They also need to see that competent management will continue on with the business after an owner transition takes place.
If the business is too owner-dependent, it could flounder and fail when the owner is no longer around. That means that well before any exit, the owner needs to put into place a solid management team that will be able to run the business according to established policies and procedures without him or her. Putting together a good management team is a challenge, as finding a way to keep key management in place over time, and through a transition, can exponentially complicate things in a lot of situations.
Owners who are “unique assets” need to find a way to replace themselves, even if they have to hire several people to do so. When buyers see a well-run organization that is profitable over time, that has a plan in place for growth, and that has policies and procedures in place that allow stability even in the event of management change, they feel less like they are taking on a risky venture and more like the business is a great opportunity to invest in.
Why Business Valuations Matter
Factors like these are just a few of the many reasons why a proper business valuation is so important. Because so much of this process is subjective, and because it may be difficult for an owner to step back and see the true value of their business, a business valuation is a great way for them to come to a solid understanding of exactly that so that they can make better and more informed choices moving forward.
At its core, a business valuation is a report compiled by a valuation professional that determines the true economic value of a business. That value will be the price a person would pay to own the business, minus any debt owed plus all cash on hand. To create this report, the evaluator will use financial statements, cash flow models, and market analysis. They take into account the unique features of the business itself, including its management and human capital.
It’s important to understand that business valuation is not the same as sale price, which cannot always be predicted, especially when the expected sale is far into the future. Instead, valuation provides a baseline financial understanding for the business owner that enables them to move forward towards a goal.
More than anything, a business valuation is a starting point for action. Once an owner knows how strong and how profitable their business is, they are much better positioned to make smarter and more forward-thinking decisions towards future goals like selling the business. A valuation can reveal that the business is in good shape for a sale, or it might reveal that a sale would be unwise at the present time. From there, the owner can take action to fix problems, instill value drivers like those outlined above, and make it stronger and more profitable over the long run.
The added benefit to all of this analysis and planning is that the valuation acts as an initial benchmark, and future valuations can determine if the actions taken were effective. For many would-be sellers, the initial valuation serves as a reality check – both for the work that they need to do to increase their business’ value and also for planning their personal finances before retirement or moving into the next phase of life.
In the end, many business owners believe their retirements will be fully funded by the sale of their organizations. But, without a proper understanding of the differences between growing revenue and growing value, that isn’t necessarily going to be the case. In reality, if they continue on without deep analysis, proper planning, and making key changes, they may have to make unwanted lifestyle reductions.
Being able to demonstrate consistent growth in value over time will not only attract many more interested buyers. It also gives sellers the necessary confidence to bargain for the best price, which may very well be the most important benefit of all.
If you have any additional questions about the differences between growing the value of your business and growing its revenue, or if you’d like to talk with a Certified Exit Planning Advisor (CEPA) about your business and its unique circumstances, contact Prometis Partners today.