Business valuation is generally made in the context of a business sale, merger /acquisition process (M&A) or as part of a funding exercise, where the owners are looking to raise external equity to help finance growth.
Although my focus is (generally) on funding and M&A, I wanted to take a step back to explain why business valuation is a critical part of the strategic decision making toolbox of owners and managers of family businesses.
There are 3 key considerations …
1. Business valuation of the family business drives your personal net worth calculation
More often than not, the value of the family owned business makes the largest part of the net worth of the owning individual or family. What your net worth is matters a lot and in many ways and is probably worth a separate discussion. Suffice to say that you definitely want to know it and that bankers and others will often ask you for it, at least indicatively as it dictates certain offerings and services that you should or should not be getting.
Furthermore, some people also think of their net worth accumulation as a target that they work towards. In the case of business owners, an important distinction is between:
- a “yield” business, which is a business that generates good revenues for the owners, either in the form of dividends or salaries or both, and
- a “value” business, which is a business that accumulates value in the business valuation itself, whereas the company becomes a highly valuable asset to the family owner, but which only generates substantial cash flow in the case of a partial or full exit
As such we see how we can go back from the net worth consideration to the company exit considerations.
2. Business valuation drives strategic considerations around partnerships and relationships with stake-holders
“My company is bigger than yours” can be a key factor in commercial negotiations. All managers are familiar with this around the angles of cash flow and profitability which can drive the balance of power between suppliers and their customers. The valuation is only a first derivative of the profitability.
Of course, any discussions around more organic partnerships, such as Joint Ventures, bring us back to the need for valuation as a decision making tool. And a JV is often very similar to an M&A transaction.
3. Business valuation drives exit discussions, which in turn impact strategy greatly
We will leave the discussion on the pros and cons of affecting a partial or total family business exit to the next blog. But the important point is that there is a huge strategic difference between running a fully owned family business and a business which includes minority investors, whether they are private equity investors or public equity (in the case of an IPO). Below are a few of these strategic considerations:
- Corporate governance is significantly different when you have minority investors as shareholders
- Employees and potential employees consider fully family owned businesses differently. And a business with a more diverse shareholder group (ideally a public company) is more likely to attract a broader (and hence better) pool of talent
- Employees in open shareholding companies (whether public or private) can get paid with equity and hence be more incentivized to perform
- As the main founder / shareholder starts exiting, even if partially, succession issues and key man risk issues become more important for minority investors
- The mere fact of considering an exit can be a distraction for management. Such periods need to be managed very carefully
- And probably most importantly, new investors will always have their opinions on the actual running of the company, at both a strategic and tactical level, and will make them heard, whether they have the governance rights to implement these views or not
In summary, business valuation is not just important for financing; it is also important for strategy.
My next blogs will deal with the financial aspects of business valuations as well as the tactics and considerations around potential exits.
In the meantime, you might find it helpful to download a complimentary copy of the 17 questions every business owner should know the answer to with respect to business valuation and exit planning.
I welcome your comments and questions below.
The concept of a “value business” is to me the most critical. A business has value when its profitability is sustainable and transferable, something more easily said than done.
Thanks Marc. I agree about this. More often than not I see people who own consistently profitable businesses hanging on to them, and needing convincing to sell when the price is right. On the contrary you see people (for example in the e-commerce world) who managed to create value without generating a lot of profits. In this case the value is based on an expected profitability which may or may not materialise. My message is that smart business owners need to know where the “price” (as defined by the market) is relative to “value” (as defined by the art of valuation) and act accordingly by either buying, selling or staying put.
Knowing your business’ value is one of the most important things that you can do as a responsible business owner. It really does effect all areas of your business and will help you make the best decisions for yourself and your business.
Thank you Greg. It kind of goes without saying, that one should know the value of their most important asset. But I was actually surprised to see how many business owners did not know the value of their business, which is why I wrote this first blog as a prelude to the series….