Small business owners often have their heart and soul tied up in their business, not to mention most of their cash! Typically, your company will be your largest investment and just as you may have a wealth manager for your other personal investments, you also need to wealth manage your business. The day may come when you will be looking at an exit strategy, and clean and lean companies bring the highest price.
Private business owners can better prepare their company for an exit strategy or simply increase the value of their business for their family by focusing on the three legs of the value stool: strategic, financial and operational improvement. Together, these legs, if coordinated and approached in a methodical manner, can significantly result in a more valuable company. The concept is called building enterprise value.
1. Strategic improvement
We will start with the first leg, which focuses on the strategy of the business in order to build enterprise value. This means positioning the direction of the company in the marketplace via four key strategic considerations:
- Market – enable the management team to do what the founder has done to date by himself.
- Decide which customers to serve.
- Develop new capabilities to power innovation, generate sales and operate more efficiently than your competitors.
- Keep the company focused.
- Management – build a high capability management team that can take you to the next level.
- Model – build a profitable economic model at a higher scale while increasing the leverage that makes the company profitable.
- Create infrastructure to support growth.
- Money – get access to capital to fund the predicted level of growth.
- Raise capital to fund growth, consistent with your company’s vision and risk appetite.
- Understand the operating changes a new capital structure will entail.
2. Financial improvement
Financial improvement involves maximizing cash flow, balancing fixed and non-fixed assets, maintaining a current ratio sufficient to cover unforeseen costs and balancing short- and long-term financing needs. This includes optimizing your balance sheet, cash flow and income statement. Key initiatives include:
- Restructure your capital structure to take advantage of lower market interest rates.
- Renegotiate supplier terms, for example to shift inventory storage and maintenance costs.
- Review your payment practices – are your payment terms with suppliers and your sales terms with customers more generous than your competitors?
- Ask if you have a large enough cash cushion to sustain the business in the event of a downturn?
- Ask if you are taking full advantage of tax strategies such as accelerated depreciation and section 179 (first year write-off) and state tax saving opportunities such as inventory location?
3. Operational improvement
Operational improvements that help build enterprise value involve fine-tuning your internal operations. Examples include:
- Supply chain – source and aggregate more efficiently the inputs that you make into products or services
- Sales and marketing - be open to re-configuring your activities. For example, replace part of your sales force with contract resources that specialize in tasks like direct marketing and prospecting leads; explore “virtual models” including using social and business networks.
- Offshore/onshore – Consider contract services (e.g., call center, order fulfillment), whether onshore or offshore, to do activities that are not core to how you add value.
- Strategic sourcing – Reduce the costs of production by sourcing from new suppliers, avoiding dependency on too few.
Focus on all three areas to build enterprise value
By approaching each of the legs of the stool on a coordinated basis, many business owners can increase the value of their business by 25% or more. The magic is in the concept of “Price to Earnings” (PE), effectively a measurement of what the market or a buyer will pay for a business.
Most businesses fall within a PE ratio of 7 to 15 times, more for a technology company with a high growth potential, less for more stable basic businesses. Applying a PE ratio of 10 times to a small improvement in earnings achieved by applying the concepts of building enterprise value yields a huge increase in value, a result of the multiplier effect.
The key is how to start. If your business is large enough, consider forming a task force to analyze possible improvements in each area. Obtain outside help from experts who can give you insights as to how other businesses have done it. In any event, your “business wealth” will increase significantly and your exit options will multiply.