This blog is about building a valuable business – it is not about selling a business. Building a business for Value gives you options.
linked to this blog.
The fundamental reason for building value comes back to why you probably started your business in the first place – FREEDOM:
- the freedom to do things your way,
- to work with who you want, when you want
- financial freedom
Only about 4% of owner managed businesses make it to the stage where the owner can really say they have achieved the freedom they are looking for –most get caught in something called “The Owner’s Trap”.
-business slows when you take a vacation
-customers come to you with problems
-your growth has reached a plateau
Not only are businesses stuck in the owner’s trap stressful to run, they’re also worthless because nobody is going to buy a company dependent on its owner
That’s why the ultimate freedom is to own a valuable, sellable business. If your business is sellable, it is not dependent on you which means you can scale, sell, pass down or simply run as your company’s chairman without being involved in the day-to-day. Building for value gives you options.
So what drives value in a business?
Some great work by a friend of mine – John Warrillow author of Built to Sell – and tested on over 14,000 businesses shows there are eight key drivers to your company’s value
I’m going to look briefly at each driver in turn and explain why the driver impact’s your company’s value
1. Financial Performance
…let’s start with the first of the Financial Performance of your business.
Remember, the goal is to build a sellable business – not necessarily because you want to sell it…
but because owning a sellable business gives you the ultimate freedom.
After analyzing thousands of transactions, we can say definitively that financial buyers only buy one things when they make an acquisition:
they are buying your future stream of cash.
Repeat: financial buyers are buying your future stream of cash. Therefore, as an owner, you have two big levers to pull on to drive up the value of your company:
- how much cash your company will make in the future
- how reliable are your estimates.
They will look at how much cash the business is likely to generate over the next few years, and then discount future cash flows depending on how risky/ how likely they think they are to happen.
This may sound complicated but it is no different from me asking you would you prefer £100 now or the £100 at the end of the month. You’d take the money now. Well what if I said £100 now or £150 at the end of the month? Some of you might be tempted, some of you might not trust that I would stay true to my word. If I was NatWest would you be more or less tempted? So you would apply different reliability/ risk according to each of us.
Likewise a potential buyer of your business would do the same – so we need to demonstrate strong financial forecasts that can be believed. Part of this is historical performance and part is future – which get us to…
2. Growth Potential
The second factor that drives your company’s value is your potential to scale up and grow in the future.
Scaling up requires you to isolate a small set of products or services to sell that meet the Trifecta of Scaleability:
Many business owners find themselves broadening the list of products and services they sell as customers ask but selling lots of things to a few customers is a recipe for your business to become owner dependent because you are likely the only person in the company with enough industry knowledge to successfully deliver such a broad product or service line.
The secret to scaling is to sell less stuff to more people.
3. The Switzerland Structure
The next factor in creating a valuable business is called The Switzerland Structure. The name comes from the country which is obsessed by remaining independent.
You too should be obsessed by making sure your business is independent of anyone customer, employee or supplier.
- From a customer perspective, your goal should be that no one customer makes up more than 15% of your revenue
- Ideally you should be able to switch any of your suppliers without significantly impacting your business
- Often the hardest part of The Switzerland Structure is to reduce your reliance on one or two key employees
The reasons these are important come back to risk and reliability – remember we want to ensure our forecast cash flows are credible and not subject to significant risk
4. The Valuation See Saw
The fourth attribute that drives your company’s value– and ultimately your freedom to do what you want with your business – is called The Valuation See Saw
It’s named after the See Saw because just like the child’s playground toy, the value of your business moves in the opposite direction of your cash flow needs. In other words, the more cash your business needs, the less it’s worth. The opposite is also true: if your business generates cash as you grow, your business will be worth more to a buyer.
The reason is simple: when a buyer acquires your business, they have to write two checks: one to you, the owner and a second check to your business to funds its “working capital” (accountant’s speak for the money you need in the bank to pay your immediate obligations like salaries rent and payables).
The money to write these two checks comes from the same pocket so the bigger the check the acquirer needs to write for working capital, the smaller the check you’ll end up getting.
Not only does improving your cash flow increase the value of your company, it also makes it a lot less stressful to run.
So what we want to try to do is to work on getting customers’ money sooner and slowing
down the speed with which you pay vendors.
5. Recurring Revenue
Next let’s talk about recurring revenue. To reiterate a point made when we discussed Financial Performance, a buyer buys your future stream of cash and therefore, the more reliable you can make your business model the more valuable your company.
The best way of doing this is to create a subscription model and although it may seem difficult in some sectors, it is possible to create a successful subscription model in any industry.
There are 9 Subscription models from simple Membership through Private/ VIP club through Simplifier – but that’s a whole topic in itself.
6. The Monopoly Control
The 6th factor that drives your company’s value is something we call “The Monopoly Control” and it refers to how well differentiated your product or service offering is.
The key thing in looking for differentiation is to ask your customers whether they care!
7. Customer Satisfaction
Not surprisingly, having satisfied customers is an important element of growing a valuable business. But having satisfied customers is actually not enough.
Your goal should be to have customers who are not only happy, but also willing to re-purchase and refer you to their friends.
That is a much higher bar to reach – as Fred Reichheld discovered. He developed something called ‘The Net Promotor Score’ whilst working at Bain.
Consistently achieving a higher than average Net Promotor Score helps drive the value of your business
8. Hub & Spoke
The final driver of value is arguably the most important. We call it “Hub & Spoke” and it is the extent to which your business relies on you personally.
The name comes from the airline industry’s reliance on “hub” airports which is an efficient was to move planes around the globe until a hub gets “snowed in” which is when the entire system breaks down.
This is where distinguishing between how profitable your business and how valuable your business is can come in handy.
Some people use profitable and valuable interchangeably but of course they are often in conflict with one another:
- Instead of hiring salespeople, the owner seeking to maximize her profits would do all of the selling herself
- Instead of hiring a management team, the owner seeking profit would likely hire the lowest paid staff they can find to simply execute
While the profit-seeker may maximize their profits, they would also grow a worthless business.
So to build a valuable business, you need to take yourself out of the hub!
So most of us started our businesses for the freedom to build something on their terms.
Most of us fall short of this dream and become trapped in our business. The ultimate goal of any business owner seeking freedom should be to build a valuable, sellable business because that gives you the best set of choices: scale, sell, pass down or become/ take on a non-executive chairman role.
If you want to know more about building value in your business then talk to BizSmart and ask about the Value Builder System TM
Remember building a business for Value gives you options.
linked to this blog.