How much is your business worth and what can you do to increase the value of what you have built? Even if you are not planning to sell your business in the near future, there are several strategies that every business owner should employ to build a better company and create more value.
As part of this effort, it is important to understand that overall value is typically determined both as a function of your earnings and financial position and the inherent strength of your business (off balance sheet items). It is not uncommon to see two businesses with similar financial profiles bring in wildly different valuations due to these off balance sheet items. While it is easy to measure the value of your financial position, understanding and improving the off balance sheet items that create and drive value are critical to positioning your company for long-term success. To help strengthen your business, we offer seven core principles that we believe separate good businesses from industry leaders.
Build a Deep Management Team
One of the most difficult challenges for an entrepreneur, and one of the critical differences between a good company and a great company, is the depth and quality of the senior managerial team. Too many entrepreneurs make the mistake of trying to run and grow their businesses with only one or two people capable of making critical decisions. As a result, most businesses will plateau in their growth. If your company cannot function efficiently without your direct daily involvement, you need to immediately begin to hire and develop talent or the future of your business is in jeopardy. Jack Welch, the former CEO of General Electric, considered talent development and succession planning one of his greatest accomplishments in his tenure. Treat this issue with the same importance.
Diversify Your Customer Base
Your largest customer should ideally be no more than 15 to 20 percent of your revenue and profitability. While it is often efficient and easy to allow a major customer to develop into a substantial portion of your sales, nothing could be more dangerous to the future health and value of a business. Once a customer becomes a critical portion of your revenue or profits, then they own you. They can begin to dictate the financial terms of the relationship, and any change in their business – be it financial, personnel or otherwise – has a direct effect on the health and value of your business. While it might require extra effort and possibly some short-term sacrifices to your bottom line as you build other accounts, the long-term benefit of a diversified customer base is a significant reduction in your financial risk profile.
Maintain Quality Financial Information
A consistent area of weakness with most small and mid-sized companies is the lack of strong financial documentation. Most business owners do not want to spend the extra money to obtain an audit, believing a review or a compilation is just as good; it’s not. Audited financials provide credibility with bankers, commercial financing sources, insurance companies and, most importantly, potential buyers. The extra money spent will be recovered in a higher premium when the business is eventually sold.
Develop a Proprietary Product or Service
To truly thrive as a company you must distinguish yourself in the marketplace by offering a unique product or level of service that cannot easily be replicated by competitors. While this seems obvious, very few companies are dedicated to creating this distinction. Ask yourself if your customers, employees and competitors can all quickly describe what differentiates your company. A superior product or service will create the opportunity for a pricing advantage in good times and customer loyalty in difficult periods.
Focus on Profitability
Too many business owners measure the success of their business on top-line revenue rather than pre-tax profitability. Value is created through maximizing profit, not maximizing revenue growth; a $25 million company earning $5 million pre-tax is worth more than a $40 million company earning $2 million pre-tax. Another common mistake is desire to limit profitability to limit taxes. While fast growing businesses often need the extra cash to fund growth, this approach loses money for business owners, as the focus becomes tax avoidance rather than operational efficiency and profit maximization. There are legal ways to minimize your taxes through use of an S-Corporation or LLC rather than a C-corporation.
Prepare and Execute a Business Plan
Establish operational and financial plans and goals for your business in one-, three- and five-year increments and share them with your employees. The plans should take into account various economic, industry and company-specific scenarios and how management would react to each. In addition to creating a roadmap for your future growth, this will focus your business and your employees on quantifiable goals and will allow you to make better business decisions as you grow your business.
Seek the Help of Outside Professional Advisors
Seek the assistance of outside professionals, especially a full-service accounting firm and law firm that can provide valuable advice as you grow your business. Not only can they provide objective counsel as you grow your business, they can help you avoid disastrous legal, financial and operational mistakes that may have significant financial consequences down the road. Similarly, if you plan to sell your business or are approached by a buyer, an investment banker can ensure you obtain the best possible transaction by restating your financials, preparing a memorandum that highlights the intrinsic value of your business (including off-balance sheet items) and quietly approaching other buyers to ensure a competitive process.
De NES Partners is a boutique Mergers & Acquisitions advisory firm dedicated to serving business owners of family and privately-held companies with revenue from $10 – 250 million. Managing Partner Doug Hubert has represented business owners/entrepreneurs across the United States in M&A transactions for over 25 years.
Mr. Hubert is a registered representative of, and Securities Products and Investment Banking Services are offered through, BA Securities, LLC. Member FINRA SIPC. De NES Partners is a separate and unaffiliated entity from BA Securities, LLC.
©2017, De NES Partners, LLC