Why Profit Isn’t Enough: The Importance of Building Business Value
We often say that we help owners increase their business value.
But what does that mean?
In simple terms, it’s an estimate of what a buyer would pay for your business.
The process of determining a business’s value involves analyzing factors such as financial statements, market trends, industry benchmarks, and the business’s tangible and intangible assets to estimate the worth of the business.
Most people only think about business valuation when selling a business, acquiring a business, raising capital, tax purposes, estate planning, or legal proceedings.
At the Alliance, we use valuation as a measure of business health. Healthy businesses are valuable businesses.
In my years as an advisor, I’ve come across many misconceptions about the valuation process.
The biggest is that many business owners believe that the value of their business is simply their profit multiplied by a market multiple.
While this is true to some extent, it is not the entire picture.
In reality, the market multiple is just part of the equation.
How business value is determined
Your business’s value is determined by both tangible and intangible assets. And while tangible assets such as financial reports, balance sheets, and property are important, they only contribute to about 25% of the multiple.
The remaining 75% is determined by your intangible assets, which I call the four Cs – Human Capital, Social Capital, Customer Capital, and Structural Capital.
Human Capital is all about your people – how your organization is structured, how your operating systems are put in place, and how your employees work together.
Social Capital is about your culture and brand, the reputation you have in the market, and how you interact with stakeholders.
Customer Capital is about the relationships and connections you have with your customers – do you have recurring business, how do you develop your customers, and how do you keep them coming back?
Structural Capital is about your company infrastructure, your technology, and your systems for managing the business.
If you’re missing one or more of these four Cs, then your multiple might be lower than what you expect.
Your valuation largely depends on the 4 Cs of intangible assets. In this example: the industry average multiple is 5. A company weak in the 4 Cs may be discounted to 3 while a company strong in the 4 Cs may get a multiple as high as 8.
For example, if you’re the CEO, the Vice President of Sales, the Vice President of Production, and the bookkeeper all at once, then you might get discounted quite a bit because you’re missing many of these four Cs.
On the other hand, if you have a fully functioning management team and you only work on the business a few times a year, your multiple might be greater because you have taken care of these four Cs.
Other factors that affect the net value a seller receives
The net value the seller receives is also dependent on paying off any debt and the cost of the transaction fees for advisors (Attorneys, Tax Advisors, Intermediary).
The seller typically keeps the cash from the sale but might be required to leave behind a minimum working capital amount in the business for the buyer as part of the transaction.
To summarize, the Market Multiple X the company performance (EBITDA) is the gross value of the business.
The gross value can increase or decrease depending on how ready the business is for a sale by having in place the four Cs.
The net value to the seller depends on other variables such as taxes, fees, and company debt.
At the Alliance, we focus on building business value instead of simply focusing on profitability.
The same structures and systems that make a business valuable to potential buyers also make it sound enough to last for generations.
By focusing on building value, you create both a stronger business and options for yourself. If you want to sell eventually, you have an asset that can fetch a high price. If you want to keep the business in the family, you have a robust and sustainable enterprise that can be passed down for generations.
Just know that building value can take time. Owners sometimes come to me with a desire to sell their business, believing it to be worth a certain multiple, only to learn that because they are so highly involved, the business is virtually worthless.
Every owner exits their business at some point. Whether you wish to sell your company one day or want to pass it down to the next generation, the time to start building value is NOW.
If you’d like some help with that, book a complimentary consultation with us today.
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