One of the hardest tasks for a business owner is working out how to set up a structure so the firm can run itself. Get that right however, and you have the best opportunity for calculating value, and eventually selling your company for a good price.
Pitcher Partner's Dr Richard Shrapnel explains how in the video below.
Read the full transcript below.
I think the day you start your business you need to think about succession and succession is about capital value. It’s not about retirement. It’s about building capital value and you’ll begin to say if the business only consists of me, what can the business be worth?
Once the business begins to get some momentum, I need to bring someone beside me who can step into my shoes and then I need to bring in another person and another person, so there’s continual stepping up and if you think of the lifecycle of the business, there are a number of points. Quite often, when a business gets to one million dollars in turnover, it struggles to go past that because it means they’ve got to take on a couple of extra people. They can’t do it themselves.
Then when they get to five million dollars, they’re now at another level. They need to have a small management team. They need to have people who they can rely on. And it’s no longer my skill as the individual business owner to make the sales, to do everything. It’s now my skill to lead a management team.
Then you go to ten million, to twenty million, to fifty million. There are points in a life-cycle where they struggle to go past that because the skill sets they need change and you see this restriction. With small businesses, they almost have a choke on them at times unless they can release themselves and begin to change their skill set from doing it myself to teaching others how to do it. That of course underpins capital value because now I have a business which doesn’t need me.
I think the ambition for every small businessperson should be to grow their business, small, medium to a level where it doesn’t actually need them, so they can continue to grow it, but then it has a capital value because someone else can now take that over.
When you come back to structure, there are two aspects. It’s how I manage the business. Who makes the decisions? What authorities have they got? What experience have they got? And how do we work as a team? And then the second part of it is how do all the different parts of the business come together to meet client need to supply client value?
If you think about that lifecycle, there’ll be stages in the business in which I need competent people who can run the business and make decisions without me. So, part of the structure is getting that structure. Do I have a sales manager? Do I have a production person? Do I have someone else in service? How do I structure it, so we actually get a focus on the client and meeting their needs or the customer?
The second part is how do all the different parts of the business work together? And in a competitive sense what we would say is today’s competition is about delivering customer value and more value than the next person. So, the question really for small businesses and medium-sized businesses is, what’s my client value or my customer value proposition? What is the value I deliver to them? Why should they come to me rather than anyone else? If I have a good sense of that, then I can build the structure of my organisation to focus on that and then I keep focusing on that and that’s where you get the compounding to become better, and better, and better, and better than anyone else and you leave the competition behind.
One of the weaknesses in many small businesses is that it’s dependent upon one person. Even if they have twenty staff, it’s often dependent upon one person and that’s the person who owns the business and that’s the person who wants to sell the business.
When they get to that stage and sometimes they’ve waited a bit too long, how can I actually transfer this? How can I take everything which has been mine for my entire life, which I’ve never allowed any of my staff here to get a handle on and transfer? And of course you can’t, and therefore what you have earned from the business is what you’ve earned and the capital value would probably be very little.
So, capital value depends upon two things. It depends upon certainty and I think it depends upon opportunity. So, accountants will look often at the profit and they’ll say you’ve made this profit over the last few years, so we’re going to take that profit. There are two ways they value. They use a multiple and the multiple is based upon risk. For small businesses often three, maybe four, sometimes five will be the multiple of what that sustainable profit is.
The other way they’ll do it is they’ll look at the future and they’ll discount it back, so it’s more like there’s a cash flow business. I have a contract. I can see the contract going for the next five years and what’s that worth? But when they do that, they’re looking at what’s happened in the past and making an assumption it’s going to go into the future.
For a buyer coming into it, they’re always going to say am I certain about this? Do I know those profits are going to be there? And the greater certainty I’ve got, the greater price I’ll pay. But it’s not only just certainty about what’s been there in the past, it’s also my perception of the future. How can I actually take it beyond what it is now? What opportunities are there which maybe have not been exploited? What are the things which I could do which the previous owners haven’t done?
Then maybe I’ll pay a premium for that because I can see what I can do with it. So, how do I be certain about the profits continuing? I need to understand what has actually driven those profits. And in most businesses today the things which drive profits are intangible. So, when we talk about the things which actually drive the profits of a business, we need to own them is number one. They need to be transferable. They need to be durable. And they need to actually deliver a competitive value.
I’ll just give you a very simple example: A business which had an agency and they’ve had the agency for many years. It accounts for a large portion of their sales. They come to sell the business and seventy per cent of their sales come from the agency. The question will be can you transfer the agency to me? And often you can’t transfer the agency. It’s non-transferable. Often the agency agreement doesn’t exist: It’s been someone I’ve known for twenty years, we never renewed it. So, in that particular case there is actually no asset. I own nothing to transfer and therefore the business has very little value.
So, when you think about your business and you think about how I’m going to grow it, you’ve got to say what actually generates the profit and what do I do to make that owned, transferable, durable and of stronger value? Now, this could be your brand. It could be your location. It could be some IP. It could be a customer list. It could be your sales skills. There are many things which are there, but you’ve really got to get behind what actually is the profit to what generates the profit.
If all of that sits in me as an individual, then once I’m gone there’s nothing left. Therefore as you grow the business you need to get that, we’ll call it the management team up and running so they can continue with the business. You need to identify the things which allow you to do what you do well. And again location, brand, IP, processes, customers, knowing what the customers want and some of the even more intangible things are culture and if you think of some of the very large companies like Apple, they have a culture which allows them to do many things. That exists in small businesses as well.
So, to me the key about building capital value is understanding what actually grows the capital value and then I as an individual business owner, how do I actually get that into the business, into the other people into the business, into the systems and processes, because I want to be able to step away from that. If I can’t, then there is no value.