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How to increase the value of your business

Posted by admin on September 30, 2009 in entrepreneur

I would like to congratulate Quick Lunar Cop, Mitch and Brian for winning the 500th post prizes. Since there were several Brian’s that entered, I have emailed all the winners. Congrats! Enjoy the prize.

Although this post falls primarily in the entrepreneurship category, if you are investor of public or private businesses, the following are some factors to think about as well when you are making your investment decisions.

In the next 15 years, it is estimated over 9 million businesses run by baby boomers will have to sell their business. The question for these entrepreneurs comes down to “how much?” For most entrepreneurs, their largest asset is their business. Unlike publicly traded stock, there is no readily available valuation for the business. Thus, it is important that most entrepreneurs think about how to increase the value of their business early and often even if they have no desire to sell now. After all, increased valuation helps in attracting good employees and obtaining capital.

While there is no set formula for increasing business value (despite what the experts may say), there are 5 things that you can do to increase valuation:

Think bottom line (profit) and not top line (revenue). I once met an entrepreneur who had consistently run every expense they could through the business. When they decided to seek financing for a new venture, the bank saw a terrible bottom line and refused to provide financing. They wondered how this person could survive for so long on such thin margins!

Beside the obvious audit risk of running up expenses, focusing on revenue over profit, in the medium to long term, typically results in a business with little cash on hand, poor cash flow management and less than ideal valuation. Even if you are not thinking of selling, this type of practice leads to a weekly grind to pay the bills. As for paying more tax on profits, paying tax does mean you are making money which is not altogether a bad thing.

Finally since people purchase businesses on multiples of earnings and rarely on revenue, high revenue growth without correspondingly growth in profits means less money on exit.

Create a unique value proposition. In 2003, PriceWaterhouseCoopers found that goodwill (an intangible asset such as a brand or reputation) represented 74% of the average purchase price of a business purchased in the U.S. Think about that for a second. People buy based on the reputation you have built and not necessarily you having the best product or service.

The foundation of a good reputation stating your unique value proposition- something that differentiates you from the competition- and carrying this through every aspect of your organization.

Think about Apple. It makes cool stuff. Its not really a computer company anymore (they dropped the ending “computers”  in their name several years ago) but a consumer goods company fusing technology with leading edge designs. Their goods look cool. Their stores are a sight to behold and they associate with leading edge people (no one had really heard of Feist in the mainstream before those 1-2-3-4 ads).

A unique value proposition is not just some cliche (trustworthy, reliable, we care about you) but a true differentiating factor from your competition. If you read profiles of top 100 fastest growing companies, the businesses on the top of those lists have a similar element- they express whatever they do passionately and it carries forward from owner to the newest employee.

Unique value propositions can take up entire books but for everyone- entrepreneur and employee alike- ask yourself this question, what is your edge and does it consistently follow through in your life?

Keep the books and financials clean. Off-balance sheet transactions, multiple related party transactions, transactions with valuation concerns, multiple notes in the financial statements- these all create the impression you are trying to juice the books. Banks tend to do double-takes in refinancing and start asking lots of questions. Potential purchasers think you are hiding something.  There are many book-keeping/accounting entries which are conventional (in and out transactions, inter-company dividends, debt to equity conversions by shareholders) but when you start doing the unconventional, it raises a concern. To use a real life example, too many financial wizardry got the financial industry in trouble and it would to your business as well.

Do you pass the test- if you went on vacation, could your business survive? If you honestly answer no, you have created yourself a job, which is fine if you are a life-style entrepreneur. But if your goal is to create something greater than you and you answered no, its time to think automation and investing in human capital. Its a huge leap of faith but purchasers and financial institutions tend to discount goodwill if its too vested in the owner-manager(s) personally.

A good place to start to untangle an over reliance on the managers it the e-myth series. The thesis of the whole series is that owners act too much like technicians and not enough like managers. My advice- find a marketer, a technician and a builder. If you have all three skill sets and can juggle the tension in all three, you have built a good team.

Can your business survive a stress test? Take away your largest customer (ideally not more than 15% of revenue). Increase the cost of capital by 10%. Assume the currency exchange rate works against you if you are in import/export. Can your business survive? Remember these are the same questions that banks, employees and potential buyers are going to ask. If the answer is yes because you have cash on hand, dominate a growing market niche and have management depth, then you are on the right track.

There is no fool proof way to grow a business but the above are some things to consider. Good luck.