Scott Snider is the President of Exit Planning Institute, the authority on Exit Planning education.
For a business owner, a notable difference exists between generating a successful net profit or annual income and building significant value. A seemingly nice balance sheet and annual profit and loss statement does not imply a company is valuable. As the president of a company that provides professional advisors with the content, tools and training needed to guide business owners, I’ve seen how focusing on building value today can help protect your business against unforeseeable future crises. Additionally, this can help ensure the company is transferrable when the business owner goes to exit and can result in increased net profit and income to the business owner each year. How do we begin to drive value while aligning your personal and financial goals with your business goals?
Through the 5-4-3-2-1 formula.
Five Stages Of Value Maturity
Think of a staircase. You start at the bottom, with the goal of reaching the top step. This metaphorical staircase represents the five stages of value maturity. Begin with identifying your current business value through an enterprise value assessment. This assessment benchmarks your company and analyzes its weak points from a buyer’s perspective.
Next, climb to the second step and protect that value by mitigating the risks within the business. Mitigating risks can drive an immediate increase in profitability while also creating more value long term.
In the third step, build upon your initial business value. When the owner exits the business, at the fourth stair, harvest the value. Upon execution of this exit, the business owner has likely increased and harvested their business value through the previous stages of value maturity. As the owner continues to walk up the staircase, the fifth step manages the harvested value from the owner’s business in their next act.
Four Intangible Capitals
Consider the first three stages of value maturity: identify, protect and build. These stages directly refer to the four intangible capitals, or the 4Cs: Human, customer, structural and social capital typically account for nearly 80% of a company’s value. I’ve found that measuring the 4Cs annually is critical to increasing net profit today while building value that is transferable to a buyer at the time of a sale.
Human capital, or your people component, includes all skills and knowledge that employees utilize in your business. This encompasses your employees’ talent and knowledge of their customers, employee retention and turnover, management succession programs, employment contracts and professional development programs. These are key components to the strength of your human capital.
Customer capital is your company’s relationship with the customer. How long has the customer been with your company? How entangled are they with your organization? How diversified are your customer base and revenue streams? View your company from your customers’ eyes to see where your business excels and the areas for growth.
Structural, the most robust intangible capital, consists of your company’s systems and processes. It encompasses everything that promotes efficiency, including technology, inventory, intellectual property, real estate, equipment, documented strategy, data and analytics, among other items.
Lastly, social capital, or company culture, embraces the people. This includes how they communicate, their beliefs and how they operate internally and externally.
In my experience, assessing your business, mitigating risk and thus strengthening these 4Cs can rapidly drive value. I think actively evaluating and managing these 4Cs daily, quarterly and annually is the most important thing an owner’s advisor can do. Strengthening these 4Cs can drive higher valuation.
Three Gaps, Three Legs
According to PwC’s lower middle market and small-business owner research, 75% of business owners profoundly regretted selling their business just one year after selling. I think it’s often likely that the owner’s advisors were not meeting all their objectives and were not holistically concerned about the owner. While the advisors prepared the business for sale and tried to get maximum value, they failed to consider two other critical aspects outside of an owner’s business: the owner’s personal vision and goals.
Business, personal and financial goals are the three legs of a stool. Picture a three-legged stool. If the stool is missing a leg or if one leg was longer, it would topple over. This reflects a business owner’s exit of their company. An owner without a holistic plan including their personal ambitions and personal financial strategy will not successfully exit in my experience.
Understanding these three legs comes from understanding the three gaps: value, profit and wealth gaps.
Two Concurrent Paths
Business owners may regret selling their business because they spent decades growing a successful business and not enough time understanding their personal purpose or developing personal goals and objectives. Meaning, they must get out of the day-to-day operations to think and act strategically. Business improvements become the first of our two concurrent paths.
In revisiting the three legs of the stool, there are two other legs the owner must concentrate on: personal and financial, which become the second concurrent path. Business owners should focus on both their business goals and their personal and financial goals simultaneously.
According to research conducted by my company, 96% of owners indicated they had no personal plans for their next act. To have a fulfilling exit, the business owner runs on two concurrent paths and visits these in 90 day sprints. Every 90 days, work on specific parts within your business as well as within your personal and financial plans.
One Goal: Drive Value
Any business owner, their executive leadership team and their advisor’s goal is to continue driving value. To solidify your personal financial plan and drive value in your personal life, your must build value in your company.
These concepts form the value acceleration methodology. When you consider these steps as one exit planning strategy, you can get started creating value for your company and aligning your personal and financial goals.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.