It’s easy to get bogged down by the day to day demands of running your business. When was the last time you thought about what your business was really worth? The value of a privately-owned business is not easy to ascertain, and as a result many business owners overlook this important aspect of running their business.
As an owner, you are likely in business not only to make money currently, but also to create a lasting value that you hope to realize upon an eventual sale as part of your exit strategy. Or, alternatively, you may plan to pass the business along to another family member or key employee. Regardless, the value that you expect at the end must be built over the years. So what can you monitor day to day that will ensure that you are truly building a value for the future?
I suggest that you maintain an awareness of two key aspects that drive business value:
- Earnings Before Interest, Taxes, Depreciation, Amortization
- Transferable intangible value.
1. Earnings Before Interest, Taxes, Depreciation, Amortization (EBITDA)
EBITDA is a measure of recurring cash flows from operations. The old adage that “cash is king” certainly has an element of truth when it comes to building business value. To the extent your business generates stable positive cash flow after all necessary and reasonable business expenses have been paid, that is a good indication that the business may have value to either sell or to pass along to your successor. To the extent that those cash flows show an ever increasing trend, even better! A potential buyer of your business will pay more (thus the business will have more value) if the business is self-sustaining and provides a good cash return to the shareholder. To effectively monitor EBITDA, the business owner should (1) track the stability/trend over time, and (2) analyze EBITDA by assessing the impact of nonrecurring events and discretionary expenses.
Windfall profits that won’t recur in the future, and unexpected expenses that won’t be borne in the future, should be removed from your EBITDA calculations so that you see a true picture of what the business can produce on a regular, recurring basis. Similarly, expenses contributing to EBITDA should be reflective of a reasonable market rate for the services acquired. Insufficient expense levels, or artificially high expense levels, should be normalized in your analysis of EBITDA.
2. Transferable Intangible Value
The second aspect key to evaluating the value of a business, transferable intangible value, encompasses a wide variety of value-building business characteristics. Included in this caption are items like intellectual property (patents, copyrights, trademarks, trade secrets); systems, procedures, or formulas that work well in delivering your product/service or controlling your business; the assemblage of employees and equipment; returning customers; familiarity aspects such as name recognition, phone numbers, websites, social media presence, etc.; and reputation or the likelihood of getting referrals made to your business.
The key to all of these items is that the quality or process is transferable. In other words, will you be able to vest in a successor those traits that have served you well in the past?
What is Working Against Building Value and What Can You Do About It?
So what works against building value in your business? And what can you do to avoid those detriments to value? The following are some common issues:
- Personal goodwill (aspects that draw the customer to the person, not the company: includes items such as credentials, specialized skills, persona, connections) Minimize this by promoting the company, not the individual, to the extent possible; employ more than one person holding critical credentials
- Concentrations (in customers, suppliers, or industry served, for example) Keep this detriment in check by constantly striving to diversify customers, suppliers, and services offered.
- Lack of management depth. Encourage delegation among your employees and cross-train employees over critical functions.
- Poor reported cash flows. Keep nonbusiness and nonessential expenses out of the company’s accounts.
- Wasteful Spending. Review processes and streamline them for efficiency.
The value of an ownership interest in a private business clearly varies based on the industry, the business’ financial results and a vast array of tangible and intangible operating characteristics. What I’ve discussed above are two of the more significant indicators of potential value that every business owner can easily monitor to ensure that they don’t lose sight of the long-term goal for their investment.
Contact DHJJ About Driving Your Business Value Up
DHJJ understands the many factors that make up the value of your business. Our Certified Public Accountants and Business Advisors can help you identify these factors and develop strategies as you look towards the future. Please contact us at 630-420-1360.
