Value Drivers

Identifying Drivers of Transferable Business Value

Fri, 09/02/2022 - 08:00

Written by: mernzen

Breaking Down Business Value 

The most significant factor that impacts a business owner’s ability to leave their company - successfully or not - is creating a company with transferable business value. 

Business value has become a bit of a buzzword, often exchanged frequently and mindlessly in business conversation. But what really drives value in business, and how do you identify the key value drivers of a business? 

A common misconception about business value is that it is determined solely on financial performance. However, in most cases, the numbers alone don’t always tell the full story. 

This is why it is crucial that business value be transferable. 

Both general business planning and Exit Planning operate with the intent to reach a similar conclusion at the end of the story: the business owner may sell their business when they want, for the money they need, and to the person they choose. 

We will examine where value is generated and where there are opportunities to increase transferable business value that include components that are not captured in the financial statements.  We’ll call these opportunities Value Drivers. 

Taking a Look at the Present 

Before any work can be done to improve business value, an important first step for the business owner is to obtain an accurate understanding of both the value of existing resources, as well as the amount of resources needed to reach their goals. Almost always, there is a noticeable and measurable asset gap between the two. 

To move past the present and closer to the finish line in the future, business owners must work to make dramatic and drastic changes that will grow business value and increase cash flow. All the while, they need to keep this asset gap in mind as work is done to bridge it. 

Transferable Value Defined: Potential Buyer & Business Owner

At the end of the day, potential buyers (specifically Private Equity Groups, PEGs) are the arbitrators of business value. The business value drivers that have been determined to be the most important have been vetted through the lens of PEGs as they buy companies based on experience, competition, and a thorough examination of potential acquisition. 

It is important for a business owner to note that even if they fear their company is too small to be noticed by a PEG or they have different transfer plans in mind, every buyer wants the same qualities in a business that a professional buyer requires. 

These qualities are the Value Drivers, each of which work toward creating transferable business value. 

Transferable business value can be defined as what a business is worth to someone else, without the owner.

Consider: 

  • Insiders wouldn’t want to risk their personal assets if the business couldn’t run without the owner.
  • Children could not take on the company if they can’t manage the operations without the parent(s). 
  • Third-party buyers would be misled to purchase a company that can’t function once the owner departs. 
  • Finally, family members of the owner might be left unsure of how to take care of the company, or risk losing their source of income, if something were to happen to the owner. 

Transferable business value is the determining factor of a business owner’s successful exit - regardless of exit path.

Value Drivers:  

So, how does a business owner identify value drivers of a business? How do they prepare a business for an eventual sell or transfer? 

  1. Next-Level Management  

Simply put, buyers are purchasing the ability of a company’s management team to perform without the owner. Management is arguably the most crucial value driver because in the end, management oversees the installment and growth of all other Value Drivers. 

It is up to the owner to decide whether existing management has the capability to grow the company at the rate required to bridge the asset gap, whether they could if provided more training, or if new management is necessary. Oftentimes, finding new leaders who have experience working in larger settings and with customers, vendors, advisors, consultants and other market leaders is what will allow the company to improve to the degree needed to reach the owner’s exit goals. 

With either option, it is key that the business owner works to instill leadership and motivation to top management so they can work towards goals with the company mission in mind.  

3 Tasks for Owners in Building Next-Level Management

  1. Operating Systems that Improve Sustainability of Cash Flows  

The creation and documentation of standard business procedures prove to potential buyers that a business will continue to be profitable after the sale or owner’s departure. Buyers look for systems and procedures that promote operational efficiency and if this Value Driver is absent or weak, buyers tend to move on. 

  1. Diversified Customer Base 

Potential buyers and investors pay closer attention to a business’ customers than they might think. A company that has high transferable business value has a healthy mix of customers that lie along various points of the buying stages. 

A common red flag to potential buyers that might decrease business value is a company that has a single buyer that accounts for more than 10% of total sales - or whose top three customers generate 40% of all sales. Customer concentration must be avoided as it is a major risk factor, regardless of exit path. 

  1. Proven Growth Strategy  

Growth can sometimes be hard to articulate. It is important to have a written plan that defines growth in the context of industry dynamics and the market’s demand for the company’s product or service. A detailed and well-communicated growth plan attracts buyers if they can see what measurable growth has been made in the past, and what actions are outlined to achieve future growth. 

This Value Driver ties hand-in-hand with Next-Level Management as those managers, with the owner’s input, will be assigning the responsibility and deadlines to complete strategy-related tasks. 

  1. Recurring Revenue that is Sustainable & Resistant to Commoditization 

The reason that revenue is a Value Driver is evident: If you were a buyer, you’d much prefer to purchase a company that makes money over one that struggles to report a profit at the end of the year. This Value Driver promotes the consideration of alternative or additional revenue streams. 

On the same note, the perception of a company’s product or service is important as well because if customers don’t view them as commodities, there is risk of losing the customers in the face of transition. The value of a company to the consumer must fall on the company’s offerings, not the company’s owner. 

  1. Good and Improving Cash Flow  

Ultimately, all Value Drivers contribute to stable and predictable cash flow. When it comes to cash flow, management needs to have the goal of increasing productivity and decreasing cost. While this is no simple task, this Value Driver depends on the effective execution of the other Value Drivers. 

BEI has teamed up with Cash Flow Mapping to provide you with the missing piece of the business succession plan: cash flow. Check out the exclusive offering below! 

 

Learn more about Cash Flow Mapping
  1. Demonstrated Scalability  

Scalability should be a major focus of one’s company because it is the quickest way to grow cash flow. Buyers demand this Value Driver because they don’t want to purchase a company that doesn’t have the capability to grow future earnings.  

  1. Competitive Advantage 

Hopefully your business owner client is aware of their value proposition and is talking about it. If they aren’t using their competitive advantage to their advantage, that is the first place to start as many business owners aren’t aware that they have one. In simple terms, the competitive advantage of any company is the offering provided that is either better or cheaper than competitors. 

Strong brand recognition and customer satisfaction are also important factors that tie into a company’s competitive advantage that will only add to a business’ transferable value. As an Exit Planning Advisor, you must help your clients identify their competitive advantage, promote it and protect it. 

  1. Financial Foresight and Controls  

Many companies lack reliable financial reporting to an extent that buyers can’t track its revenue. It can also indicate that a company does not have competent management in place that can report on their financial performance. It’s important for potential buyers to be able to see the projected cash flow in a way that makes sense, as well as analyze the costs of implementing the growth plan. 

Timing of Transferable Business Value

Naturally, the sooner a business owner begins to improve their company’s Value Drivers, the more the company will benefit. The key as an Exit Planning Advisor is to encourage business owners to begin building this transferable value right away. Oftentimes, if owners wait until they are emotionally prepared, they will be faced with a handful of challenges, including: 

  • Decreased passion and motivation to build value and push business growth 
  • Years of cash flow forfeited 
  • Decreased satisfaction with ownership experience 
  • Limited exit path options with more pressure riding on the challenges 

Still not sure how to entice action from your business owner client? It’s your job to ensure that they are not scared off by a lack of time or knowledge - you can help them begin improving transferable business value today. Schedule a meeting with us to get started

 

To read a real-world case of a company who identified Value Drivers and took action to find success, download our free, featured resource below!

Case Study: Schumacher Steel

Identifying Drivers of Transferable Business Value

Providing Excellent Service but Losing Clients?

Fri, 07/02/2021 - 08:00

Written by: eswanson

Is it possible to provide great value and service to your clients but still end up missing opportunities with these same clients? Sadly, as the following case study illustrates, the answer is yes. 

Louis Packer’s financial planning practice was stagnating and beginning to lose long-term clients. He was dismayed and baffled: Clients often said that his firm offered great service at a fee equivalent to those of other financial advisors is his community.  

When one of Louis’ long-time clients, Audrey, called to say that she was switching advisors, Louis finally had the courage to ask, “Why?” 

He discovered that Audrey wasn’t leaving for lower fees and better service. She was attracted to one of his competitor’s approach—an approach that Louis didn’t provide.  

Audrey explained that she was switching to a financial planning firm that offered a service that she wanted and needed—a service that Louis did not. Audrey was interested in exploring ways she could exit her business while maintaining her lifestyle.  

In this blog, we will discuss how Louis’s competitor attracted Audrey, but first let’s review what most professional advisors provide: regardless of our profession, we provide the same process, products, and service as our competitors provide (or promise to). 

Just like Louis, each of us believes that our process, products, and services are better than the rest. But what Louis learned the hard way was that clients don’t (or can’t?) appreciate marginal improvements in process, product, and service. They can, however, appreciate how we differentiate our practices from those of our competitors.  

Just for a moment, step back and ask yourself: How is your practice different from your competitors’? Put another way, what do your competitors offer that could attract your clients and possibly already has?  

New call-to-action

Using Louis as an example there are several possibilities: 

  • Lower fees: Cost is a practice differentiator, but not one you likely want to pursue, much less maintain. And, as Audrey illustrates, cost is not the primary draw that attracts successful owners to professional service providers. 
  • Niche services: e.g., Exit Planning or qualified plan design. 
  • Niche products: e.g., Alternative investments. 
  • Niche industry: Practice focused on clients in a specific industry: e.g., Steel building contractors. 
  • Different fee structure: Value-based billing instead of AUM (Assets Under Management) fee or hourly.  

Whatever attracted Audrey was something that differentiated her new firm from Louis’s firm and his competitors. That sounds a lot like a competitive advantage.  

The lesson here for us as advisors is that if we are to maximize the growth of our practices, we have to charge less (low-cost competitive advantage) or provide something viewed as more beneficial to owners than our competitors provide (differentiation competitive advantage). 

Which leads us back to the question: How do advisors retain their existing clients and attract new ones? 

One approach advisors use to answer this question is to be acquired by a larger organization, e.g., a regional CPA firm, larger RIA, financial planning practice or law firm. These larger firms offer the specialized services business owners seek. Being acquired is a viable and common solution, especially for those interested in exiting their practices! 

A second approach requires advisors to differentiate their practices by acquiring expertise, tools, processes and/or products that clients want and need and that competitors do not offer. Remember, clients don’t buy our services because they like them. They buy them to solve a problem or seize an opportunity. Your differentiation proposition must do one or the other. 

A third approach is to acquire new, often larger, and more profitable clients. This strategy also requires you to differentiate your practice from competitors.  

With the exception of rolling your practice into a larger organization, an ideal strategy to create a competitive advantage based on differentiation is to enhance your core offerings and become a skilled Exit Planner. With this gained skill set, you will have the resources necessary to market your planning more efficiently, recruit other like-minded professionals to your planning team, and create and execute successful business exits for your owner clients. 

Follow us on LinkedInFacebook, and Twitter to stay up to date on all current Exit Planning news and trends.

differentation

Business Value Drivers

Wed, 07/09/2014 - 15:51

Written by: eswanson

In my last blog entry, I talked about transferable value: the value buyers look for and pay for when making acquisitions. That entry focused on how Value Drivers increase transferable value if they contribute to cash flow both during and after the original owner’s tenure.

Determining how to increase transferable value is the business owner’s job. However, once owners and their advisors determine which of the Value Drivers (listed below) must be strengthened, everyone in the company should be involved. By definition, business owners cannot do it alone. If they could, they wouldn’t be creating transferable value, because once they departed, the Value Drivers would disappear.

As you read through the following list, remember that it contains only “generic” Value Drivers. Depending on what your company does, it may have other factors that create and increase transferable value. Additionally, there’s no particular order to this list, except for the importance of the management team: It is management that creates, manages, and grows these essential business characteristics, which is why establishing a best-in-class management team is always the most important factor of creating transferable value.

Common Value Drivers

  1. A stable, motivated management team that stays after the owner leaves.
  2. Operating systems that improve the sustainability of cash flows.
  3. A solid, diversified customer base.
  4. Recurring revenue.
  5. Sustainable revenue, resistant to “commoditization.”
  6. A competitive advantage.
  7. A documented and proven growth strategy.
  8. A demonstrated and successful acquisition strategy.
  9. Financial foresight and controls.
  10. Good and improving cash flow.
  11. Scalability.

Let’s look at each of these Value Drivers in a bit more detail.

  1. A stable, motivated management team that stays after the business owner leaves. If you plan to take any Exit Path other than liquidation, capable management is indispensable. Having best-in-class management is the surest way to become a best-in-class company. Capable management is what buyers buy when owners sell their businesses, so establishing the best possible management team will make it more likely for you to receive the best possible price for your business.
  2. Operating systems that improve the sustainability of cash flows. The establishment and documentation of standard procedures and systems demonstrate to a buyer that the business can maintain profitability after the sale.
  3. A solid, diversified customer base. Buyers typically look for a customer base in which no single client accounts for more than 10% of total sales. A diversified customer base helps insulate a company against the loss of any single customer.
  4. Recurring revenue. As a buyer, wouldn’t you want to acquire a business that prints money with the push of a button? Recurring revenue is that button that buyers look for in purchasing a business. Without recurring revenue, you may struggle to find a buyer who is willing to pay top dollar for your business.
  5. Sustainable revenue. Buyers look for revenue streams that continue despite fluctuations in the economy. They also prefer those that are resistant to “commoditization,” which is when a company, product, or good loses its distinctive attribute, forcing that company, product, or good to compete based on price alone, which leads to slimmer margins.
  6. A competitive advantage. To paraphrase Michael Porter of Harvard Business School, competitive advantage is a product or service that a company offers that, over time, performs either better or more cheaply than its competitors. Your company’s competitive advantage is the reason your customers buy from you instead of your competitors. Thus, having a strong competitive advantage can differentiate you from the rest of the pack, and if that differentiation is positive, buyers will be more likely to pay top dollar for it.
  7. A documented and proven growth strategy. Even if you expect to retire tomorrow, it makes sense to have a written plan describing future growth and how that growth will be achieved based on industry dynamics; increased demand for the company’s products; new product lines; market plans; growth through acquisition; expansion through augmenting territory, product lines, and manufacturing capacity; and so on. This detailed growth plan, properly communicated, will help attract buyers. Buyers will give credence to your current growth plan if previous plans have achieved their goals.
  8. A demonstrated and successful acquisition strategy. When applicable, having a demonstrated and successful acquisition strategy can go a long way in proving your company’s commitment to detail and wise investment.
  9. Financial foresight and controls. Effective financial controls protect company assets and support the claim that a company is consistently profitable.
  10. Good and improving cash flow. Ultimately, all Value Drivers contribute to stable and predictable cash flow. You can begin increasing cash flow today by simply focusing on ways to operate your business more efficiently by increasing productivity and decreasing costs.
  11. Scalability. Could your company improve its profit margin if it increased its revenue? Considering value-added services or even creating a mobile app can contribute to the company’s scalability.

Creating a plan to increase transferable value in your company is your job. No one else cares nearly as much as you do, and no one else will reap as great a reward for making sure that your company has the most transferable value it can. However, executing the strategy to increase value is everyone’s job. If you don’t already have top managers and skilled advisors ready and willing to provide ideas and implement Value Drivers, I suggest that you recruit them. Today.

7-ways-to-build-and-capture-value-in-your-growing-business