Financial Confidence is Key to Small Business Success [Transcript]


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[Plan Your Future Today]


[Cathy Hagan, Business Consultant, CEPA]


Cathy Hagan:

Today, we’re going to talk about exit strategy, and more importantly, how to use that excess strategy to maximize the value of your business so that when you’re ready to exit, you can reap the rewards of all the hard work that you’ve put into your business. Oftentimes, business owners don’t want to talk about exit because it’s a little scary. Maybe if you’re just getting started in your business, it seems very far away. You’re more focused on launching the business, launching the ideas, marketing, those types of things. Or maybe you’ve been in business for a while and you’re reaching retirement age, as many folks are, the baby boomers of the world. And maybe you equate putting together an exit strategy as defining your mortality, and maybe that’s a little scary. Or perhaps you are kind of scared about what you would do after you exit, and you have no plan for what you’re going to spend your time on. You’ve devoted so much to this business.


So what we’re going to talk about is how to build in an exit strategy into your overall business strategy so that you’re maximizing the value over time, and therefore, be able to realize that value when you are ready to exit. If we make exit strategy part of your overall business strategy, not only does it maximize the value for when you do exit your business, but also it makes it a more solid, profitable business today. So we want to look at some things that drive value. And if you look at business valuation, there’s a formula that is often tossed around by CPAs or business brokers that look at the value of a business based on a number from your financial statements and some multiple.


So it could be, I’m going to do, your business might be worth some multiple of earnings. So two to five times earnings is oftentimes something that’s quoted by CPAs. Why you pick two and why you pick five is where we look at really what I would call the art of business valuation, is how do you determine the multiple that’s going to be attached to that number from your financial statements? And that multiple is really driven by the intangible assets that you have in your business. It’s not so much profits, or sales, or things on your balance sheet, but really what does that intellectual capital that your business brings to the table that adds value that, as a result, will increase sales, increase profitability. So we want to look at what are those intangible assets or what you might call intellectual capital that lives in your business, and how can you use that to build the strength of your business and maximize the value?


So, number one, we want to look at human capital, because really, bottom line, your people are the most valuable assets that you have in your business. They’re the ones that deliver the products, create the products, provide the customer service, provide the customer experience. So if I have a good strategy in place to recruit good, solid employees, to retain them so they stay around, and to really motivate them to pursue the success for the business, then you’re going to add a lot more value to your business, and therefore, be able to increase that bottom line, increase those sales revenues.


So in probably one of the most important things with human capital from an outsider perspective, is what’s the tenure? How long do people hang around? Do you have a lot of turnover? And if so, maybe evaluate why. Perhaps you’re not recruiting the right people or there’s some compensation gaps that you need to fill in order to attract the top talent, or maybe you’re hanging on to some folks that are maybe more warm bodies than productive, A-players in your business. So taking a look at your organizational structure and do you have the right people in the right seats to help run your business successfully. So understanding the value of that human capital and how those employees, the key management team, really drive the success of the business.


Another intangible asset maybe I would put on the same par as your employees or your human capital would be your customer capital. And that’s really the relationships that you have with your customers and how deep those relationships run. Do they depend on you for unique products or services that they can’t get anywhere else? Do they have a long history with you? Are they loyal to your brand? And more specifically, do they need you in order to create value for their own customers? One of the things you might want to address within the customer capital is checking out, do you have one customer that makes up 25, 35, 50% of your revenues? That’s kind of a red flag in terms of valuation, because if that one customer goes away, then you really have to work hard to make that up. So thinking about how diverse is my customer base, and how loyal are they, and what kind of relationships do I have. Perhaps there are contractual agreements that cover multiple years, maintenance agreements, really loyal customer service. So that customer capital really a critical piece.


Third, we look at structural capital. And structural capital really is how you run your business, the day-to-day operations. What are the processes in place that you have in order to do whatever it is that you do? And how well documented are these processes? Oftentimes in small businesses, the owner and maybe the key management team are the only ones that know how to do certain things. Or there’s a key person on the front line that knows how to do certain things, but nobody else does. This makes it difficult to have those processes add value because someone coming in from the outside may or may not be able to handle those processes, make them happen. So it’s really important from a structural capital standpoint to have things documented, policies and procedures, cross training, those types of things to build that structure so that it does have value.


And then finally, we look at the social capital. And this is the brand, the reputation, the culture of your business that drives value from an outside perspective and kind of generates enthusiasm internally so that your team wants to work hard to build that brand, to represent that culture. If you want to think of Google or Zappos, those are great big businesses that have an awesome culture, and people want to work there, and because of that enthusiasm, people want to buy their stuff. So how can you think about that social capital as it relates to your business? So those are really the intangible assets or intellectual capital that you can use to drive the value of the business, to drive that multiple from a two to a five.


But probably most important related to this intellectual capital is, is it transferable? Can I transfer the quality of my team to someone else? If there was an outside person that came in to run the business, would that team be just as loyal as they are to the current owner? Are my customer relationships transferrable, or is it really based on how they deal with the owner and they really would not work with your business unless it was for you, the owner. So how can I spread the love, if you will, with customer relationships so that they have a relationship with the business, not just with the owner.


Are your processes transferrable? And this really relates to documentation. Once again, do I have things in place to be able to show people how I do what I do? Do I have, as the owner of the business, ever written down a day in the life of a business owner? What do I do? What am I responsible for, and so that I can transfer that to a new owner? Can you transfer your culture to someone else? Can they take that culture that you’ve built within your business and take it over as an individual owner or integrate it into another business that might be looking to acquire yours so that value of the brand still exists. The social capital is there. The reputation transfers with the business and doesn’t stay with the owner.


And kind of encompassing all of this, is your business owner- independent? Can it survive without you? Can the reputation survive without you? Will the employees continue as a team if you’re not there? Will the customers continue to come back? Can you go on vacation for a week or two weeks or a month and the business can still run, it is still profitable, still successful? So key ingredients to maximizing the value of your business, not only when you plan to exit, but also through the course of operating the business over the next several years, so that ultimately the value will be there when you’re ready to exit.


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