Your Business Value vs. Market Correlation

It is a fact that a privately-held business will, in most cases, represent the largest financial asset in a business owner’s personal portfolio.  This newsletter is written to have business owners consider a simple question – ‘how correlated is your business value to the overall economy?’  The reason that this question is so important to ask is because most business owners put the majority of their financial wealth at risk when they fail to view their business as an asset; in particular, as an asset that fluctuates in value.  Therefore, this newsletter is designed to get you, the owner, thinking about protecting your overall wealth by thinking through a potential future date when you will transition your business – perhaps before the next economic downturn. Investing 101: Diversify Your Assets It has been said that there is such a thing as a ‘free lunch’ when it comes to investing – that ‘free lunch’ is the diversification of your assets.  The reason that diversification is called a ‘free lunch’ is because in a liquid portfolio of investments (i.e. stocks and bonds), diversification costs almost nothing beyond some transaction costs.  However, the low / no cost of diversification provides a substantial amount of benefit to the investor because the investor is not solely invested, or ‘concentrated’ in a single investment or perhaps in only a few investments. In fact, in a well diversified portfolio, different types of assets / investments rise in value in certain markets while others will fall.  Overall, the investor is provided protection of their wealth by spreading it out. However, when a business owner’s largest asset is...

Can a Business Exit Plan Make You Happy?

Owning and running a successful privately-held business is a constant challenge that is full of obstacles and opportunities.  It is pretty well understood that putting your business (and personal) plan down in writing tends to increase the chances of achieving them.  However, what is less often discussed is how you might feel when you apply a high level of discipline to planning the future.  If, in fact, you value the freedom and financial benefits of owning a privately-held business, then it is also likely that you place a high emphasis on not only what the business can provide to you but how you feel about the business and its future.  This newsletter is written with the purpose of answering an important question, i.e. “Can planning for the future through an exit plan make you a happier business owner?” A Recent Study Tying Planning to ‘Happiness” In a Planning and Progress Study performed by Harris Poll on behalf of Northwestern Mutual, 2092 American adults (18 years of age or older) were ranked in four (4) categories of ‘planners’: 1. Highly Disciplined 2. Disciplined 3. Informal 4. Non-planners When the survey turned to the topic of retirement, 91% of Highly Disciplined planners were ‘happy in retirement’ while only 63% of non-planners could make the same claim.  It appears, therefore, that those who plan, tend to be happier when the time and occurrence (i.e. retirement) that they planned for arrives. All owners will one day exit their business, either voluntarily or involuntarily.  Therefore, can the Harris Poll survey results regarding retirees in general be applied to business owners? “Happiness” for Business Owners...

What Factors are the Largest Detractors of Value for my Business?

Business owners who are thinking about an exit often-times want to know what challenges they will face in a sale process and whether or not someone else will want to own their business after them.  A solid exit planning process includes both personal and business factors to be considered.  On the business side, it is helpful for an owner to know about the elements that are likely to reduce the value of their business in the eyes of potential buyers.  When an owner is aware of these factors, it is likely that these ‘risks’ can be mitigated over time, leading to a higher exit value for the business.  This newsletter takes a look at the factors that generally reduce the value of a business and provides some recommendations as to ways that owners can address these items years in advance of an anticipated exit or sale transaction and therefore increase not only the potential value of the business, but also the overall likelihood of a successful sale. What Buyers Fear Most As an owner who is thinking about a future exit, you are well served in understanding the concerns and fears of potential buyers for your business.  The largest fear that a buyer has is that of the unknowns and the risks that accompany not knowing what the future holds.  In other words, privately-held businesses do not report earnings in the manner that publicly traded companies do.  Therefore, when it comes time for a buyer to review your business for purchase, they will have countless questions about how the business operates, the markets that it serves, key people who...

Is My Industry the Largest Driver of Value for My Business?

Business owners considering an exit often want to know who their likely buyers will be and how much money those buyers are willing to pay. In order to forecast a realistic sale price, owners often look to standard metrics such as the ‘multiple of earnings’ – a valuation theory based on the idea that similar assets sell at similar prices. This way of thinking often leads business owners to the quick conclusion that the easiest way to increase their business value is to increase the earnings of the business. This newsletter examines that basic concept and challenges this conventional thinking by first asking the question, “Does the industry that you are in have the largest impact on the value of your business?” Value is a Prophesy of Future Cash Flow The most important concept in valuation is the idea that a future buyer for your business will pay you for the cash that they expect to generate from your business in the future. A prospective buyer will only write you a check for your business if they are confident that there is a ‘future’ for your company. The price and terms a buyer will pay are driven by the riskiness of the future, as they perceive it. There are three (3) important items to consider: Increased profitability will generally drive your company value higher. Reduced risk in your business will also drive your value higher. The industry in which you exist will produce willing investors who can best evaluate the risks of future cash flows. In reality, in order for an owner to monetize their illiquid business, they need...

Are Your Company’s Earnings or Risk Factors More Relevant For Your Successful Exit?

Most business owners at some point in time want to know the value of their privately-held business.  Further, many owners who see their ‘exit’ as being many years in the future would like to know what they can do today to improve and grow that value. This newsletter asks a rather simple question for owners to consider today, “is it better to increase your profits or to reduce your ‘transition risk’ in order to increase the value of your business?” The Risk and Return Formula For Valuations A buyer of a business will pay for the cash flows that they believe will happen in the future, which is measured by the overall riskiness of those forecasted cash flows being achieved. Let’s translate this a bit further.  A business is worth what someone else is willing to pay for it – that is the ‘price’ at which a business may sell.  However, the ‘value’ of a business today can only be measured using certain specific ideas about how a future buyer would view the business.  As a general rule, buyers will pay for future cash flows but only at a rate at which the riskiness is properly reflected.  Therefore, a complete analysis of how to increase the value of your business must include both increasing profits (i.e. cash flows) as well as analyzing and reducing risks in the business. EBITDA Multiples Many owners are familiar with ‘industry multiples’ for sales of businesses.  For example, many owners will understand what it means when someone says that “Jim sold his manufacturing company for ‘5 times’ the company’s earnings”.  The ‘5 times’ is...