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To start this discussion, we’d like to acknowledge that the issues related to valuation and sale of service-based businesses are broad and complex. They are certainly not issues that can be dealt with in a short piece like this. That being said, we would like to share some of the issues our Advisory Team deals with on a regular basis.
In today’s business environment, many successful companies can be classified as service-based businesses. This might involve selling professional or trade services, providing brokerage services or acting as agents for the distribution of products. When an owner decides he wants to sell the business, he or she must be able to demonstrate that the business can continue to generate cash-flow subsequent to the sale. This is fundamental when it comes to the purchaser’s perceived value of the business.
The question on most purchaser’s mind is whether the customer relationships will continue post sale. When advising our clients, we need to demonstrate the difference between business and personal goodwill. Business goodwill is the portion of a business’ value that cannot be attributed to specific assets. Generally, business goodwill arises from a combination of customer relationships, brand value, employee relationships, business systems or proprietary technology. Personal goodwill, on the other hand, is the value that relates to specific abilities, skills or relationships of a single individual. This individual is usually the owner. In theory, only business goodwill can be transferred to a new owner, and personal goodwill cannot; however, the lines between business and personal goodwill can become blurred. For the most part, personal goodwill has no commercial value because it cannot be transferred.
In the case of service-based businesses, it is critical that we can demonstrate that customer relationships can be transferred to the new owner. This requires us to demonstrate that the underlying goodwill is attached to the business and not specifically to the owner. The best way to achieve this goal is to have a functioning management team in place that is capable of effectively operating the business when the current owner is not present.
There are many benefits of good management, but it’s a goal that is very hard to achieve for many reasons. First and foremost, most entrepreneurs enjoy having complete control over their business. Second, they like the perceived security of controlling the customer relationships. We use the term perceived, because in our view, there is more security if you transfer the relationship from you, as the owner, to the business. If the customer feels confident that there is a team looking after them, that ensures consistent and high-quality service, then they are far more likely to stay a loyal customer. In addition, by putting a management team in place, you as an owner can concentrate on growing the business rather than getting bogged down in day-to-day client service. Though this may all seem like common sense, it is far less common that you might think.
While it can take a couple of years to put all of this in place, we believe it is never too late to make the changes required to make a business more attractive to a potential purchaser. It generally takes some time and requires a financial investment, but the effort will likely pay off in terms of the price and terms you’re able to negotiate when you decide to sell your business.
CPA, CA, CBV
Partner - Advisory Services
Mike has over 25 years of experience providing accounting and business advisory services, with a focus on the Canadian insurance industry.
CPA, CA, CBV
Alex Wong is a partner at Smythe Advisory and is focused on being a trusted business advisor to his clients.
CPA, CA, CBV
Director of Valuation Services
Paul Woodhouse focuses on providing financial advisory and litigation support services to clients.
Gagandeep specializes in M&A advisory engagements, as well as business valuations in the contexts of management buyouts and succession planning.
Arthur’s mandate is to assist Smythe clients in Western Canada in preparing for and executing business divestitures or acquisitions.