Valuing Your Business – Does Management Really Matter?

July 10, 2019

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Yes, management does matter. But rather than end here, let’s take a deeper look at management in terms of how it ultimately drives the value of a business.

Management and Business Value

What is Management?

As a starting point, it is important to understand what we mean by management. We refer to management in the context of the business processes that operate the various systems required to deliver consistent, and hopefully growing, financial results. We are not talking about the business skills of the owner.                              

No one should underestimate the challenges in developing an effective management system. Most businesses start with limited financial and human resources. Typically, the owner is also the manager and he may have little experience in developing systems that are scalable. Add on to this, that most profit is needed to repay debt, fund working capital and provide for the owner’s family.

Typically, management systems do not keep pace with the needs of a growing organization. Systems are introduced when the business is small and as the business grows, new systems are introduced on an ad hoc basis, or current systems are adapted to keep pace with new volumes. The amount of time and effort required to operate these inefficient systems, makes it difficult to even consider stepping back to consider new, or better ways, of doing things. Ultimately, this does tend to impact the valuation of the business.

As business transition and divestiture advisors, we are often approached after a decision has been made to sell the business. In fact, it is our experience that only a small percentage of business owners do any pre-sale planning. Unfortunately, the result of a business owners lack of pre-planning, might mean that the business is not sellable.

While it might take a year or two, there is a lot a business owner can do to implement better management systems that can turn the company into a sought-after asset. Ultimately, the enterprises value is about long-term cash flow and the ability to transfer goodwill.

Goodwill is the price you receive for your business, less the fair market value of the underlying identifiable net assets such as inventory and equipment. You might think of goodwill as all the intangible assets such as customer relationships, systems, organizational know-how and even geographic location. Practically, goodwill is the amount someone is willing to pay for the future cash flow they expect to receive from your business. The key to its value is the transferability. And the key to transferability is the underlying management of the business.

How to Increase the Value of Your Business

While it is not easy to operate a well-managed business, the framework for well-managed businesses is consistent. So, what does good management look like? We’ll say it can take many forms depending on the size and life stage of a business. We can also say that a lot can be done in a relatively short period of time to make a significant difference in the market’s view of the future financial results. While not an exhaustive list, here are some typical management changes that might help transfer goodwill:

  • Ensure the accounting system can produce accurate monthly finance statements for at least twenty-four months prior to the sale;

  • Do an expense audit and eliminate unnecessary expenses that tend to creep into the business over the years;

  • Make the investment with your current system or create an ancillary system that can show the profitability or financial contribution by product, services, customer or geographic region. This can often be done relatively easily with Excel and a little know how;

  • Deal with redundant or under-performing employees;

  • Update and implement better credit, invoicing and collection procedures to improve work in progress or receivables lock-up;

  • For those businesses that have physical inventory, undertake an analysis of inventory turn-over and, if necessary, make changes to inventory management systems;

  • Promote or hire management that can remain as leadership of the business after your planned exit date, and

  • Ensure all corporate records, contracts and regulatory matters are available and up-to-date.

It is surprising how resistant business owners can be in undertaking the process to update their management systems. It might feel like this is a judgement of their skills as an owner or that the ultimate financial return is not worth the work required. Trust us when we tell you that the return is worth the effort.

This is not about the owner’s skills, but simply preparing the business to be presented in a manner that a purchaser can understand the cash flow that is available post-closing. If they are not confident about the quality of those earnings, they will either back away from the deal or lower the offering price. We try to help the owner to see his or her business from the perspective of an outsider – someone who has no emotional attachment to the business.

Entrepreneurs and business owners spend their careers meeting and over-coming challenges. As one gets closer to the finish line, the preparation to maximize the valuation of their business is a challenge worth facing.

Selling a business is perhaps the biggest transaction a business owner will ever make. At Smythe Advisory, we understand the importance of getting it right and have a team of dedicated professionals to guide you through the whole process, from preparing your business all the way past closing. As every transaction is unique, all of our services are customized to meet each of our clients’ needs.

Our team will work seamlessly with your other professional advisors to ensure all your interests are met during the divestiture process. We have connections with all the major law firms in Vancouver, Langley and Nanaimo and are well-networked to provide qualified recommendations.

If you are thinking of selling your business, or are curious as to what it is worth, please do not hesitate to contact one of our team members directly, click on the Get in Touch With Us button below or try out our handy pop-up chat on the bottom right corner of this page.

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