IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities. Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family-owned businesses. The following blog article has been provided by Huba Rostonics of ThriveMonger (https://thrivemonger.com/):
Selling Your Business For More
How business valuation depends on removing “you” from “your company”
Let me just say first, I am not an expert in pricing businesses. I consider myself more of a “strategy and operations guy” than anything else. After saying that, you may be wondering why should you even read this article, why am I even writing it. Well, the reason is that I have been involved in operating companies -large and small- for over two decades, in different capacities, and when you spend enough time in the entrepreneurial and business community, you start to see patterns that emerge.
Every person that deals with business valuation -may it be for assessing funding rounds, IPOs, or for buying and selling businesses-, will eventually mention what I call “The Big Three”. Sure, there are other factors besides these three, like debt/asset ratio, vertical industry where the business operates, etc. but those tend to take a secondary role, and sometimes they determine the amount of cash out, but not much the actual price.
THE BIG THREE
So what are these “Big Three” factors? It comes down to EBIDTA, Growth, and (this is the one that I can have a lot of fun with!) the viability of the business without the founder (make that the owner, founder, or operator).
If you are looking to buy or sell a business, you probably understand why the first two are important. EBIDTA (earnings before interest, depreciation, taxes, and amortization) is a good measure of what the new buyer can expect as a return from buying the company; and Growth is important because it indicates whether if that return can be expected to stay the same, increase, or dwindle in the future.
But I would argue that the viability of the business without the leader is the one that can have the most dramatic consequences. Why? In simple terms, “Joe’s Plumbing” is not the same if Joe is no longer in the picture.
VIABILITY OF A BUSINESS WITHOUT THE FOUNDER
Dependence of a business on its owner can take many forms. Among them, could be the particular expertise that the founder has -like in the case of an architectural office, or a photography studio-, where the clients may be paying for the specific deliverables that the business founder is capable to produce; the particular brand that the experience or fame of a person brings to the business -like in the case of many fashion brands (Karl Lagerfeld, Chanel, to name two), or high-end restaurant chains (Emeril’s, Don Shula’s Steakhouse for example)- where the original concept has been shaped by the individual; or -most commonly- the way the founder/operator manages and runs the business.
Out of these three, the most complex to extricate is the last. Expertise can be built in the team overtaking the business, and the personal brand can be managed by maintaining certain standards, or even establishing some licensing arrangement.
In contrast, it takes a very long time to get the founder/operator of a business to set up a system where they can stay out of the daily operations. The good news, is that we have known how to do this for a few years already. The “turn-key business” revolution that arguably got started by the seminal book “The E-Myth” by Michael Gerber has been proven to work wonders in these lines.
AN OPERATING FRAMEWORK FOR YOUR BUSINESS
You have probably heard the phrase “Operating System” (or O/S) in the context of computers and mobile phones. A computer operating system defines frequently repeating operations and makes them easier to execute. For example, managing the different resources available, managing, and prioritizing different tasks that are running concurrently, and the way the device interfaces and communicates with the user and other devices. By doing so, the O/S simplifies work for the user, and frees-up developers from having to program once and again each of these functions. An operating system brings order, stability, and simplifies things.
This is true regardless of who is using the device!
Similarly, a Business Operating Framework is a comprehensive framework and a set of processes that an organization can utilize to manage and streamline its operations, ensuring that it functions efficiently and achieves its strategic goals. It usually encompasses organizational structure (people!), processes & policies, and tools, including technology. It helps in aligning the business from its core values and mission to its day-to-day operations; and by using a common, shared language, enables seamless communication and collaboration among employees. It may include additional, higher-level processes, like a structured approach to decision-making, resource allocation, performance measurement, and even a way to conduct meetings. Business operating frameworks impact how a company adapts to changing market conditions, drives innovation, and maintains a competitive edge; and the same way as a computer operating system, it brings order, stability, and simplicity to its operation.
Again, regardless on who is leading the organization!
WHAT DOES AN OPERATING FRAMEWORK CONSIST OF?
Let’s first say that there is no way a business can function without some kind of a framework. Sometimes it is plainly referred to as “this is how we do things over here”. Even though most businesses already have one, it may still not be the best one for them. Some signs that this may be the case, is if there is constant conflict, frequent fire drills to be able to perform tasks that should be routine, and just a general feeling of dysfunction. Another important measure of the effectiveness of a business operating framework, is how often and to what degree of detail does the founder/operator have to make decisions. Do they get asked constantly? Do they get involved in every detail of the work being done?
Leading operating frameworks consist of three major building blocks. The first, foundational layer is what defines what the business exists for, and who those working in the business are, what do they stand for. This foundational layer makes everything else more intentional and aligned. Sometimes it is just inherited from the founder’s personal values and goals, but it can still be vocalized.
The second major building block is the day-to-day operational layer. This contains most of what makes the business function. The organizational design, who reports to who, what is what each person does and is responsible for, what are the processes that are carried out to satisfy their customer’s needs, how performance is measured and rewarded, and finally, how is communication and collaboration done, and what are the tools utilized.
Most small business owners tend to stay in this layer. Working “in the business”, doing things. They are a team member, as much as a leader and a coach, and their time is consumed by operational responsibilities.
This brings me to the third and final building block: the business management and high-level process layer. Mature entrepreneurs and business leaders must be able to dedicate a significant portion of their time to work in this layer, to work “on the business” instead of “in the business”, meaning that they should dedicate an important chunk of time to work on the development of strategy and to make any high-level decisions that will help address any emerging threats or capitalize on new opportunities, instead of being immersed completely in sales, or in the daily operation responsible for any deliverable. The more this is true, the more viable the business is without their direct involvement, and hence, the higher the valuation of the business.
Even the smallest businesses can benefit from adhering to a business operating framework, as the establishment of repeatable processes, and policies that avoid the need for repeatedly making the same decisions over and over, can save time and effort, and deliver more consistently for customers. Even if you have a pretty good business operating framework in-place, part of running on a world-class one is having feedback loops and a processes for continuous improvement.
For more about this, download our free Business Operating Frameworks implementation guide, and get started on your journey to a higher valuation.
If you have questions relating to the content of this article, Huba Rostonics would welcome the opportunity to talk with you. Mr. Rostonics can be reached at (954) 727-3350 or huba@thrivemonger.com.
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, real estate, accounting, legal, and financial planning communities on subjects relevant to the purchase & sale of privately held companies and family-owned businesses. IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.