Your most valuable asset: Managing your system integration business as an investment
As a business owner who wears many hats, it’s easy to get caught up in the day-to-day workings of the business. However, it’s critical to the company’s long-term success (and any retirement goals) to carve out time to look at the business as you would any other investment. Sounds easy enough, but it’s not easy unless you know where to start.
Whether there is a plan to sell the business in the coming years or pass the business on to the next generation, knowing the value of the business investment and how that changes over time is critical. Once the value of the business is determined, it is then possible to increase value or to know if management decisions are resulting in increasing value over time.
Transferability: Is the business going to attract buyers?
Before getting into the details of business valuation first determine if the business is "transferable," meaning it would be worth more than liquidation value and therefore attractive to a potential buyer. There are two questions to consider:
- Are there profits available to the business owner to provide a return on investment? Is the business profitable? Secondly, is it profitable after adjusting to market levels of compensation for the business owners?
- Is the business too dependent on the business owner? If the business owner becomes seriously sick, injured or dies, would the business’s operations continue and survive long-term?
If the business is profitable after adjusting for market compensation so the business owner can earn a return on investment and the business can continue without the business owner, the business would be considered to be transferable by appraisers.
If the answer is "no" to the first question, or "yes" to the second question, unfortunately the business is likely not transferable. It is possible to become a transferable business; however, this takes time and investment.
Who might be a buyer for a system integration business?
Once the business is transferable, it’s time to think about the type of buyer who may be interested in the business. Again, whether there is a plan to sell now or in the future, understanding who the potential buyers might be and making sure they know about the business can help define how to transition out of the business smoothly.
Interestingly, every privately-owned business has many different values depending on who the buyer of the business might be.
As shown in the buyer’s ranking chart in Figure 1, different types of buyers are willing to pay different values for a company because each group is motivated differently and perceives risk differently. The buyer types in the chart in Figure 1 range from those who would likely offer the lowest enterprise value (that is, the lowest sales price), such as the undiversified passive investors (level 1), all the way up to the highest enterprise value, the strategically positioned buyer (level 9).
The following are some tips to determine who the buyer of a business might be:
- Check the buy-sell agreement: If there is a partner in the business, are there any stated provisions about what types of buyers the business can be sold to within the agreement?
- Identify the exit objectives: Do you want or need to keep your business within your family or certain group of employees? Or, no matter what happens, are you just looking for ways to maximize sales price? While it may change over time, put your exit plan goals in writing.
- Determine your potential buyer types: Based on the chart in Figure 1 and the objectives, what two to three buyer types would be the best fit to sell the business to when the time comes? Top price might be most important, or other factors, such as job security for the employees.
- Keep a running list: Who are the top five contacts in order to sell the business today? While the list is sure to evolve over the years, record ideas about possible buyers for the business and become more knowledgeable about the industry.
- Market the business: Make sure potential buyers know about the business even before the thought of potentially selling. Write in industry publications or speak at industry conferences about some the business’s success.
Before selling, identifying who the buyers might be and what their expectations and concerns might be will position you to make changes to maximize business value.
Business valuation: It is not about a multiple
Many business owners have a number in their head that they need the value to be, but are left unsure how much the business is actually worth. So, in an effort to save time and/or money, some owners will ballpark value with their accountant using multiples of earnings or revenues. There is so much more to a business than a number on an income statement multiplied times a baseless number. When valuing a closely-held business, using just a multiple is meaningless.
Since we should not just rely on multipliers of a number on an income statement, experienced business appraisers will look at three approaches to value a business: the asset approach, the market approach and the income approach. All three should be considered when determining a meaningful conclusion of value, although not all are weighted equally in the final conclusion. Depending on the purpose of the business valuation, the income approach is typically used.
Under the income approach, the historical financial information needs to be reviewed for the specific company but also to "look under the covers" of the business for the story behind those numbers. While past financial performance is certainly an important driver of value, there are numerous factors, or levers, that drive value beyond revenues and profits.
Ways to drive value to a business
There are many ways to increase value in a business. Many business owners find themselves busy every day, yet they may not see the business results they are looking for. It’s especially frustrating when these results are inconsistent with industry trends.
Successful people often rely on a variety of managerial frameworks to help them make sure they are on track with both strategic plans and implementation. With consistent use and time, the framework summarized in the graphic in Figure 2 can help you focus on the right activities to drive value in your business.
Here are some examples of questions you can ask yourself for each value driver:
- Financial performance: Are the right services being promoted, at the right prices, to the right customers, to get to the profits needed? What do the historical trends for revenues, gross profits and operating expenses indicate in the last five year-end income statements?
- Growth potential: Is the company keeping up with industry trends in terms of process, products, pricing and quality of employees? If the industry is stagnant or in decline, are there adjacent services that could be offered to customers, or a way to package services for a new group of customers in a similar industry? Does the company culture and processes support a growth mindset?
- Switzerland structure: Is one employee heavily relied upon, or customer, or supplier without whom the business would be at significant risk? How can the customer base be more diverse and how can the company cross train employees and identify backup suppliers?
- Valuation teeter-totter: Are sufficient cash flows created to support day-to-day needs of the business? Develop a relationship with a bank early on and explore if working with that bank is best long-term.
- Recurring revenue: How can consistent cash flows be created with recurring orders versus starting from scratch each month? Is there a way to make any part of the business a "subscription" or retainer-type of business?
- Monopoly control: What is the "why," or reason the company exists, and how is the company delivering what competitors cannot or will not deliver? Do employees clearly understand the "why" and "how" so they can consistently deliver on these fundamental messages in communications and through client deliverables?
- Customer satisfaction: Is there a consistent and measurable way to get feedback from clients? Are employees trained and empowered to handle customer complaints or share customer praise to ensure the company is doing the right things and immediately making it right when it falls short?
- Hub and spoke: How are advancement paths being created to retain key employees for their best interest, but also so that the business is not as dependent on the business owner on a day-to-day basis? Has a succession plan been identified and are the right players on the current team to deliver on that plan today, if needed? Are systems, procedures, and history documented?
This useful framework begins to illustrate how much more goes into the value of a company than just the financial results, and should spark some ideas on what questions need to be asked to help focus on the value drivers of a business. Identifying and discussing these topics with business partners, leadership team, or other trusted advisers is an important starting point to driving value in the business.
Creating a buy-sell agreement
Protecting the ownership interest, or "share," of the business is critical. Don’t get into business with anyone (family included) without first defining how to get out of business.
Defining "fair" and reasonable ways to undo the relationship become difficult once a triggering event actually occurs, and those involved too often end up in a courtroom. It is important to consider each possible triggering event and define the intent of the owners before it is known which individual will be leaving the business.
The way to define and document how to handle the buy-out of one (or more) of the owners is by creating a buy-sell agreement. The buy-sell agreement outlines what happens to the shares of an owner who leaves the business, for any number of reasons. It is a legally binding agreement that is typically drafted by an attorney.
When an owner leaves the business, the most critical paragraphs (referred to as the valuation provisions) of the buy-sell agreement define how the departing owner’s shares are to be valued. Unfortunately, these valuation provisions are too often ill-defined or non-existent. The key to well-defined valuation provisions is to consider all the possible triggering events and then define the owners’ intent under each event-not just in the case of death or disability. At a minimum, have an independent business appraiser review the valuation provisions and give feedback to the existing language. The goal is to have an unambiguous agreement that defines how the owners will act under any possible triggering event.
For immediate action steps, jot down the two to three of the most obvious opportunities (or glaring issues) to tackle immediately, then consider two to three more for the next six months and so on.
If you walk away with nothing else, please take the time to review (or create if needed) the buy-sell agreement in place if there is more than one owner in the business.
Catherine J. Durham is accredited senior analyst, principal, and president, Capital Valuation Group; edited by Emily Guenther, associate content manager, Control Engineering, CFE Media, firstname.lastname@example.org.
- How to drive value to a business.
- How to attract potential buyers.
- Identifying what to consider when potentially selling a business.
How often should a business valuation be considered?