Building Value in Private Companies: Now is the Time to Devise a Plan to Build Value in Your Company

Every year, business owners set new goals to retain customers, expand products or services and build their client base. But how often do owners of private companies sit down to devise a plan to build value in their company? The need for building value is in the present, not in the future when a partner is ready to move on, or a sole owner is ready to sell or transition the business to a new owner. Developing a strategic and tactical plan to build value in the business can help owners plan ahead for their eventual exit.

“Value Build”

Business values at their root are a function of the cash flow you would expect to receive in the future (including growth) from your investment in the business, the time you expect to remain as an investor, and the return of and on your investment. This return includes your perspective on the relative risk of achieving your goals.
Simply stated . . . Value is a function of cash flow, growth and risk.

This statement represents how businesses are actually run and, for better or worse, one component of value cannot "move" without the other components being affected.
We know that business valuation is an intellectual exercise and not a one dimensional formula with "inputs". It is the result of the dynamic interaction of key components that are inseparable; namely Cash Flow, Growth, and Expected Returns on and of capital invested.

Communication between the business owner(s) and their advisory team is the foundation for a successful "Value Build" and exit plan. Developing clear goals and objectives is one of the first steps. And a business valuation is many times the rallying point for a successful exit plan, no matter what the time horizon.

For example, consider two competitors in the manufacturing industry; they are similar in size and their recent financial performance shows $1 million of EBITDA (earnings before interest, taxes, depreciation and amortization).

Company 1's advisor stated the general rule of thumb used for such manufacturing companies is 5 times EBITDA, meaning the company in his eyes was worth $5 million.

Valuation using multiple approaches:

Let's look a bit deeper . . . Company 2's client list was well diversified (Company 1's was not); Company 2 had a succession plan; (Company 1 did not); Company 2 had a proactive approach to business development (Company 1 was dependent on the owner). Using the multiple of 5, both companies would be valued identically . . . but which company would you be willing to pay more for? Which has more value?

These so-called rules of thumb or multiples based on some financial measurements are not useful tools to determine the current worth of an operating business. Sure, they are simple to use and on the surface easy to explain, however they are at best an incomplete way to gain insight into the value of a business. Isolated financial ratios represent perhaps only a glimpse into a company's value. This approach ignores business and other related information that could influence the company's value such as: relative performance, growth prospects, management, and competitive advantages to name a few. In addition, such general approaches to business valuation fail to consider one of the most important questions . . . "Who wants to know what the business is worth?"

A valuation may use multiple approaches and will purposely include the owner and management team's knowledge in order to take into account all of the unique factors relevant to the business. A business valuation is a unique combination of art and science and should not be reduced to the use of a calculator and a table of figures.
If your yearly check up doesn’t include a strategy to build value in your business, you may want to schedule an appointment with your advisor to discuss the steps you can take today, to build value for tomorrow.

Steve Egna is the Director of Business Advisory Services for Teal, Becker & Chiaramonte, CPAs, P.C. (TBC). Egna authors the “News You Can Use” newsletters and provides readers with insight to business valuations, transition planning, mergers and acquisitions and strategic planning.