When business owners talk to me about increasing the value of their business, the conversation usually turns to growth. New customers, another location, more staff, perhaps buying a competitor.
Growth matters. But it is slow, it needs capital and it brings its own risks. It can be years before the effort shows up in the price a buyer will pay.
There is often a quieter opportunity closer to home: making the business you already have less risky.
Same profit, different value
When we value a business, we usually start with two things: the earnings a buyer can reasonably expect to continue, and the risk attached to those earnings. The first gives you a profit figure. The second largely shapes the multiple applied to it.
So two businesses with the same profit can be worth very different amounts. One has reliable monthly reporting, a capable management team, a broad customer base and processes that are written down. The other relies on its founder for most decisions, earns most of its revenue from a handful of customers and has no real succession plan.
A buyer will pay more for the first. Not because it earns more, but because its earnings look more likely to survive a change of ownership.
Growth works on the earnings. Reducing risk works mainly on a buyer’s confidence in those earnings, and that is where the multiple comes from. It isn’t a formula. Fixing one weakness won’t automatically lift the multiple, and some risks matter far more to buyers than others. But where risk is what’s holding value back, dealing with it can be cheaper and quicker than chasing more revenue.
Where to look
I find it useful to think about risk in three places.
Personal: what happens if the owner or a key person becomes ill, loses capacity or dies?
Financial: is the business adequately funded, are the numbers reliable and is the debt sensible?
Operational: how much depends on particular customers, staff, suppliers, or knowledge that lives in someone’s head?
Some fixes are quick: better reporting, updated agreements, documented processes. Others, like reducing a business’s dependence on its owner, take years. That’s the best argument for starting early.
Authority isn’t capability
I was reminded of this while working with a family business whose founder’s health was declining. The next generation was already involved in running it, but the situation raised two quite separate questions.
The first was legal. If the founder could no longer make decisions, who had the authority to act for him personally, as a shareholder and as a director? Those are not the same thing. A power of attorney deals with personal and financial affairs, but it doesn’t automatically put anyone in the director’s chair. That depends on the company’s constitution and how the board and shareholdings are set up.
The second question was harder. Was the next generation ready to lead?
Documents can give someone authority. They can’t give them judgement, relationships or the confidence of staff and customers. That comes from years of being handed real responsibility, ideally well before it’s needed.
Whether a business is eventually passed to family or sold to an outsider, both questions need good answers. A buyer will certainly ask the second one.
Protect, then build
Chris Snider’s Value Acceleration Methodology describes five stages of value maturity: Identify, Protect, Build, Harvest and Manage. What I like is the order. Protect comes before Build.
That doesn’t mean growth should wait until every risk is gone. That’s neither possible nor sensible. It means asking a simple question before the next expansion plan: if something went wrong tomorrow, how much of what I’ve already built would survive?
Sometimes the most valuable thing you can do for your business isn’t to make it bigger. It’s to make it less fragile.
Further reading: Christopher Snider, Walking to Destiny, which sets out the Value Maturity framework referred to above.