When my daughter was in preschool, I spent many nights reading to her about the adventures of princesses like Ariel, Aurora, Belle, and Rapunzel. Girl Dads know when you read these stories enough times, you know them by heart! But fairy tales are not just for little ones. Let’s meet a Wealthpreneur who is the hero of his own business ownership adventure.
Once upon a time…
Douglas Barnes is the fictional founder of a family-owned Midwestern manufacturing company. Barnes Manufacturing LLC’s specialty products are in great demand, the company reports high pretax profit margins ,and it consistently achieves its core capital target.
Thanks to his master’s degree in engineering from MIT, Doug personally designed all the company’s major products. A handful of key customers account for more than 60% of the company’s revenue, and Doug knows all the company CEOs by their first names. He personally closes every major new customer contract. Doug has not taken a day of vacation since he founded the company 25 years ago! The annual cash flow to owner exceeds $5 million.
Investment bankers, business brokers, private equity firms, and strategic acquirers frequently inquire about purchasing Barnes Manufacturing. When Doug hears stories about the dangers of the 5 D’s, he meets with a Certified Exit Planning Advisor (CEPA) to discuss the valuation of his business and its future sale potential.
Doug is devastated to learn his company lacks transferable business value. He realizes receiving a premium price purchase offer from a prospective buyer is unlikely. Doug’s CEPA recommends taking several strategic steps to close the “value gap” between his company’s current value and its much higher potential value that will make his business more attractive to potential buyers.
Doug immediately begins to implement the strategies his CEPA recommended. Barnes Manufacturing is on track to becoming a much more valuable business! And they all lived happily ever after.
One man’s treasure is another man’s trash
According to business valuation expert Chris Mercer, there are two kinds of business value: your business’s value to you as an owner, and its transferable value.
A business may have a different value to different potential owners, depending on each person’s perspective. The value of a business may even be unique to a specific owner. This “special value” can be caused by the owner having one or more of the following mindsets.
- My business is my life. If a Wealthpreneur cannot imagine life without owning and working in their business, they may miss excellent opportunities to transition ownership of the business. They may even turn down premium-priced offers because they simply cannot let go.
- My business gives me prestige. Successful Wealthpreneurs often become very active in their communities. Because of their business ownership, they are able to lead fund-raising efforts, serve on charitable organization boards, and headline industry events. These owners fear that if they transition out of their business, they will lose the prestige from participation in these activities.
- My business funds my lifestyle. For many Wealthpreneurs, the investment income generated by the after-tax proceeds from a business sale would not solely support their current lifestyle. To close this “wealth gap”, owners can increase their business value or modify their lifestyle. In some cases, a combination of these two strategies is necessary.
- My business needs me. A Wealthpreneur’s active participation is often critical to their business’s success. The owner may have deep customer and supplier relationships, special knowledge or skills, and other key attributes. Unless these key person risks are significantly reduced or eliminated, the business is worth more to the current owner than to any prospective buyer.
Wealthpreneur Lesson
Author Verne Harnish on leadership
“The best leaders have the right questions, but turn to their employees, customers, advisors, and the crowd to mine the answers. Every business is more valuable to the degree that it does not depend on its top leader.” (Emphasis added.)
READY, set, go!
Transferable value is what a business is worth to a buyer without its current owner. To grow your business value and increase your transferability, I recommend you consider Chris Mercer’s READY framework.
- R – Risks. If business risks are reduced, the value increases (with all other things equal). If two nearly identical businesses, one riskier than the other, were put on the market, the risker business would likely sell for less and take longer to sell. Before you transition your business ownership, reduce risks such as key person, heavy customer concentration, and narrow product line offerings.
- E – Earnings. In accounting jargon, cash flow is often referred to as earnings. Companies that generate higher pretax profits than their industry competitors are better positioned for sale at a premium price. With all other things equal, increasing your expected future cash flow will raise the value and attractiveness of your business.
- A – Attitudes, Aptitudes, Actions. Does your business foster earnings growth and risk minimization? Are you working to enhance what your business produces or provides? A business with momentum toward improvement has more transferable value than a stagnant business. As Zig Ziglar said, “Your attitude, not your aptitude, will determine your altitude.”
- D –Driving Growth. Cash flow growth increases the value of your business. With all other things equal, a fast-growing company is more valuable and transferable than its slower-growing competitors.
- Y — Year-to-Year Comparisons. Perceived business value is often influenced by trends in your company’s revenue, pretax profit margins, and other key performance indicators. With all other things equal, a company with improving performance is more valuable and transferable than one with declining key performance metrics. Such declines can occasionally be explained as temporary, but they may still foster difficult negotiations. To achieve a greater exit value, the seller may even need to accept an “earnout” arrangement to protect the prospective buyer.
Closing the gap
Building transferable value in your business can create opportunities for you to manage the wealth you created. During this process, you will need to close your three gaps: profit, value, and wealth.
The insights above were inspired by the teachings of Chris Mercer. For those interested in additional information, I recommend his book, Unlocking Private Company Wealth.
