Every business shares at least one business objective: wealth creation for the owner(s). Every business has goals, stated or unstated, but all business owners want to be rewarded for their risk of investment.
Business owners may be compensated for their work but they also the desire to earn a return on their investment. What separates an owner from an employee is the risk of invested capital. Every privately owned business will eventually encounter one of the following succession transactions.
· Selling the business;
· Passing the business to a family member; or
· Winding down and liquidating the business.
Business owners should begin implementing strategies well in advance (5 years or more) of the succession event.
Understanding business value
It is critical to understand what generates business value and how to position the business for maximum value. Business values are often discussed in the terms of a multiple of cash flows. The multiple is simply the price paid for the business divided by the operating cash flow generated by the business. Many factors influence the value of a business, cash flow is just one. Many businesses that seem very similar in nature, trade for very different multiples, as evidenced by price earnings ratio (P/E ratios) of similar, publically traded companies.
There are many factors that influence business value including strength of product line, strength of distribution channels, depth of key personnel, and exclusive and/or geographic coverage.
Business owners should consider two initial steps. First, carefully review the operating characteristics of the business to identify those areas where the business generates profits and how well the business stands against competition. This process is often an in-depth SWOT analysis (strength, weaknesses, opportunities, and threats) to understand where strategies are needed to improve and capitalize upon business operations.
Secondly, the business owner should compare the characteristics of their business to similar businesses that have been sold to determine what factors drove business value. A great deal of information of recent private company sales is available in free and subscribed data basis systems.
Strategies to increase business value
Sustainable trends will help to increase business value. The investor in your business will want to be able to project the potential of future profits and cash flows. There are a few fundamental ways to make a company more profitable and thereby increase its value.
· Increase Sales
1. Consider an in depth review of the business marketing plan, product packaging and delivery, and customer service activities. Many times a company can promote product or service superiority to differentiate themselves in the marketplace.
2. Consider raising prices. Fear of competition and current economic conditions often makes companies hesitant to raise prices. A small price increase is not likely to be so significant to drive customers away, but will help to avoid larger price increases later just to keep pace with cost of living increases.
3. Review your sales reports, determine how much your largest customers purchase in a year then consider new ways to obtain longer term supply agreements with your customers such as price discounts for multiple year supply commitments.
4. Take steps to increase sales distribution channels. Distribution is all about getting products/services to customers in a timely fashion with consideration for profit and effectiveness. Evaluate how your end-users need to buy, and match your end-user needs to a distribution strategy.
· Improve the quality of your assets
1. Stay up to date with accounts receivable collection efforts. Track key performance indicators such as the number of days sales in accounts receivable. Consider allowing early pay discounts to customers or finance charges to those who pay late. A buyer of your company would not want to deal with constant collection issues.
2. Pay close attention to inventory turnover performance indicators. If your business turns over its inventory (converts inventory to sales) better than your competitors, your will business will be more valuable to the potential buyer.
3. Many businesses make the mistake of becoming too conservative as the succession event approaches, such as deciding to put a hold on new capital equipment purchases. Aging equipment and/or service fleets will distract from the business value. It is the same concept of estimating the cost of repairing or updating a house when offering a price for the purchase of a new home. If the business buyer will have to incur capital equipment costs soon after the purchase, it will distract from the amount they are willing to pay.
Purchasing new equipment should also increase productivity. Increasing productivity—making more with less—is a key way to increase profits and business value. Streamline processes, and where possible, centralize similar tasks and have standardized procedures.
Whether or not you have a clear goal to transition your business in the future, increasing your company’s value is a smart way to achieve improved business results. By working ON your business and not just IN your business you can generate a larger return on the time and the capital you have invested in the businessBy focusing on business improvements to increase your company’s value, you will directly benefit from a company that gives you greater returns.