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So, What Drives Business Value?

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Author: Paul Cronin - Apr 2016

“There are approximately 23 million businesses in the United States, and yet only a few hundred thousand are able to be sold each year. This means for every small business owner who creates a business that someone will buy, there are about a hundred businesses that do not sell.” (1)

Most owners think their Company is valued by their profit and loss statement. They utilize industry benchmarks as a multiple of profit by which to assess the transferable economic value of their business. If this assumption were true, why then do we so often see one company [in the same industry] selling for as much as 2 to 3 times multiple differences?

Jim Collins, in his book, Good to Great, identified that “gold medal companies” outperformed their “silver medal” counterparts by as much as 15 to 1.

  • So why is it that 90% of business owners do not achieve the value for their business that they expected (2)
  • Better yet, what did the 10% successful owners do to earn many multiples more in transferable economic value?

The price an investor is willing to pay for a company relates to how risky he or she perceives the future stream of profits to be: the riskier the investment, the higher the return an investor will demand. This translates to a lower multiple on earnings. Risk is mitigated and multiples grow dependent on how well an owner has institutionalized their business.

In its simplest form, transferable economic value is a combination of two “buckets”. The Performance bucket (measured by a company’s profit and loss statement and balance sheet) and the Risk bucket.

  • Performance = generating returns that are recurring, while
  • Risk Management = minimizing the risk of achieving those returns.

Ninety percent of business owners focus on performance, working “IN” their business. Only a few business owners understand the importance of mitigating risk and what areas of their business they need to work “ON” to improve the overall structure of their business.

The areas of business the investor community focus on in their due diligence are referred to as “value drivers”. Knowledge of these value drivers and knowing where to focus resources to enhance them is at the foundation of building a more valuable business.

Whereas publicly traded companies have immediate understanding of their value [and liquidity] through the “stock market”; privately held companies have had no such visibility, short of engaging a professional valuation company. As such, privately held companies are rarely assessed and when they are, it is usually when an owner is ready to sell. Which, when it comes to maximizing value in time for sale, is usually 2 – 3 years too late.

Finally, We Have Visibility

In 2010, serial entrepreneur and author John Warrillow created a statistically proven algorithm, based on 36 questions, to help owners of privately held companies understand the 8 value drivers of business and determine to what degree their company has maximized each of these value drivers.   Currently more than 18,000 companies have completed the Value Builder questionnaire. The [Value Builder System™] algorithm has been successful in helping owners understand their risk multiple and where to focus their resources to grow the value of their business.

To learn more about the 8 drivers of business value and gauge how well you and your leadership team are doing in maximizing your business value, I invite Owners/CEO’s to complete the Value Builder questionnaire.  Click on this link to take the free assessment:  Get Started_ copy

Conclusion

It is not a mystery what owners need to do to create a more valuable business.  “Transferability” is key, but most owners of closely held companies don’t get that. The Venture Capital and Private Equity groups understand this dynamic well and invest where required to make sure the transfer of the business doesn’t jeopardize the earnings stream.

The 10% successful owners understood that value is driven by the salability of the overall structure of the business. As such, they institutionalized their business with the Framework, Discipline and Tools historically known to make companies great.

A statistically proven assessment tool exists for owners of privately held companies to understand the 8 drivers of business value and where they should focus their resources to enhance the value of their company.

Finally, business systems [like RFB’s “Strategic Execution”] are available to help owners and their leadership team implement the Framework, Discipline and Tools to become “great” companies.

Footnotes:
(1) John Warrillow, serial entrepreneur and author of “Built to Sell” Copyright 2010
(2) ROCG Americas collected 502 surveys from privately owned business owners predominately in the United States and Canada from March 20, 2007 through December 18, 2007. Data was collected both on-line and in writing. There were 91 Canadian respondents, 386 United States respondents and 25 Other/Non–disclosed locations. The annual revenues of the respondents ranged from under $1M to $100M.  http://sgllp.com/uploads/business_transition/ROCG_SrvyBroch.pdf

 

About the Author: RFB Business Advisor, Paul Cronin, is a leader in strategic execution, exit and transition strategy, and succession planning. He specializes in working with owners and their leadership teams to create, grow and preserve wealth. Connect with Paul and other RFB® Business Development Advisors here, or on LinkedIn

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