How to manage an automation or system integration business as an investment
Part 2: Integrator update on creating business value with a focus on transferability. Would the system integration business, automation industry consultancy, original equipment manufacturer, or panel builder be attractive to a potential buyer? See two factors used to determine business value and five ways to create a transferable business.
As the classic saying goes, "beauty is in the eye of the beholder." Likewise, the definition of a successful system integration firm or other automation industry business can vary greatly depending on a business owner's goals.
The owner may consider the system integration business to be successful, but the real question is whether or not someone would want to buy the business when the owner is ready to sell. The question is important because a business can be successful without being an attractive investment opportunity for a buyer.
Two asset value factors
While many factors must be considered when talking about the actual value of a business, there are two key questions business owners first need to answer to determine if the business is even transferable. In other words, would an educated buyer want to buy the business for more than the value of the collected assets? The two simple questions below can generally uncover whether or not a business would be attractive to a potential buyer or if it would be classified as more of a successful career someone has built using the tools of the trade.
1. Do the profits available to the business owner deliver a return on investment? To determine that, first, is the business profitable? Secondly, is it profitable after adjusting to market levels of compensation for the owner or owners?
Not all business owners pay themselves market levels of compensation. Market compensation is the salary the owner could earn working as an employee of another company in the industry. To estimate market compensation, identify the title and/or job description and search online for estimates of market compensation (Salary.com, PayScale.com, Monster.com) or obtain an estimate from your industry association's Salary Survey. [Also see the 2016 Control Engineering salary and career survey.]
To get an accurate view of cash flows and profitability, adjust the profits to account for market compensation, regardless of what the owner is actually paid as an employee. After adjusting the number up or down so the expense reflects the market level of compensation, is the business profitable?
2. Is the business too dependent on the owner(s)? If the owner becomes seriously ill, sustains injury, or dies, would the business' operations continue and survive long-term?
Is it transferable?
If the business is profitable after adjusting for market compensation AND the business can continue if the owner no longer can work, then business is considered to be transferable.
Learning the key drivers of value in a system integration business can further increase the value of the business. A wise business investor should always be interested in increasing value.
If you answered NO to question 1, or YES to Question 2, unfortunately the business is unlikely to be transferable at this time. Making it a transferable business requires time and a commitment to invest in people and/or systems, along with a willingness to delegate to others.
If the business is not profitable and not generating sufficient cash flows for the owner to earn a return on investment, it would be wise to consult with an accountant or business adviser to identify specific ways to increase profitability. Questions related to profitability might include:
- Does the problem reside in not having sufficient revenues?
- Are services and products priced too low?
- How do margins compare with others companies in the industry? (Check with benchmarking data.)
- Do you need to structure employee compensation differently?
- Does a customer or group of customers have high needs and low profitability? (Is it time to say goodbye to some customers?)
5 ways to transferability
A fictitious business called ABC System Integrators provides an example of how a business can be too dependent on the owner.
ABC System Integrators is owned by Jim, and Jim is the only point of contact for key customers. Jim believes he is the only one who can treat the customer the way he/she wants. Jim also does the accounting for the business and does not share the financial results with anyone else in the business. Jim handles all payroll so no one else sees what others are paid. Lastly, Jim has the majority of the company's processes and techniques in his head and enjoys having it that way, because clients and employees go to him for the answers and solutions. Jim is unable to leave the business for even a week's vacation, but he likes the feeling of being needed. He likes that clients call and ask only for him.
Unfortunately, such a business cannot survive long-term without the owner's day-to-day involvement. So, when it comes time for the owner to exit the business (or if the owner dies suddenly), the only option is to liquidate the business's assets.
If the owner's goal is to eventually sell the company for more than just the value of the tangible assets, here are a five ways to create a transferable business:
- Train, cross train, educate, and motivate key people to stay in the business
- Stop meeting with and/or communicating with key clients alone
- Delegate, delegate, delegate
- Encourage staff to solve problems on their own, using resources you've made available
- Document processes in a central place that all can access.
A great way to test how accomplished the owner is at creating a transferable business is to ask if the owner could be absent from the business for a month and only call in to wish someone a happy birthday. Despite the usual hardships from being down one person in management, would business operations successfully continue?
There are many other ways to make a business transferable, based on the specific business situation. Whether your system integration business is transferable today or not, commit to knowing the situation and working towards creating a transferable business.
Future articles in this nine-part series will discuss other ways to increase business value; some can be surprising.
- Profits and owner dependency can determine a businesses' value.
- Five ways a business can improve business transferability.
Fostering self-sufficiency among employees, rather than dependency on the owner, adds business value.
See part 1 of this series, "Create engineering value in an automation or system integration business," linked below.
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