How to Change the Valuation of Your Business

How to Change the Valuation of Your Business

The Power of Doing – Part 1, Taking a Good Look in the Mirror

As we approach Thanksgiving and the end of November, we enter the classic end of year/beginning of new year cycle of evaluation, analysis, planning, and commitment to the future.  What has your year been like?  You’ve had challenges no doubt because there is not a year that goes by where there aren’t challenges.  Have you had a good year?  A less than stellar year?  No matter what kind of year you’ve had or what challenges you’ve had one thing is certain.  This year is gone and it isn’t coming back.

Isn’t that how it goes?  Each year we look back and we think about how fast it went and how it kind of slipped away from us.  I know that’s the way it has been for so many of my clients over the years.  Here they are in their 60’s or more and they’re talking about how they really should be doing something to be sure they’ve got a way to stop working, transition out, have financial independence.  Dude, if you’re in your mid to upper 60’s and you expect to significantly change your outcome, I have some bad news.  Unless you’ve got another 5 to 10 years of energy and commitment not much is going to change.

Is that the way it’s going to be for you?  Are you going to start each year with the best of intentions only to let each year slip away from you with all the challenges that distract your attention day after day, week after week, month after month, year after year, until you too are the owner in your 60’s, tired, wanting out, and facing a financial outcome that is not pretty at all?

It doesn’t have to be that way of course.  You could be among the minority of owners who take charge of their future, who set out a course of action and in spite of the challenges manage to stay on track.  So to close this year, I’m going to map out for you the proven paths I have found that allow owners to get the outcomes they want.

Author Michael Podolny at Google+

Valuing a Small Business-

Transferring Ownership to Financial Independence

Common Sense Strategies for Valuing a Small Business Higher

How Using Free Cash Flow Translates to Financial Independence (Part 4 of 4)

We’re finishing up our discussion of earning a good return on investment on our businesses and having that contribute to our ability to achieve personal financial freedom.  In the last post I discussed how the overall equity value of the business could be used to achieve those goals.  In this post, I will be showing how taking out a portion of the cash/profits produced each year by the business and investing them can greatly increase an owner’s return on investment.

Why is this?  It’s because this strategy is additive to the overall equity strategy not an alternative to it.  It is like getting twice the value from the same investment.  Let’s look at the variables that need to be considered for this strategy to work.

For income distribution to contribute to personal financial freedom, it must be done on a consistent basis and those proceeds must be actually be saved and invested.  Therefore these variables need to be accounted for:

• Owners must distribute money on a consistent annual basis and have the discipline to save and accumulate those funds
• A rate that can be safely distributed must be calculated after accounting for taxes and necessary reinvestment in the business
• An intelligent, conservative, consistent investment strategy to produce a compounding effect on the proceeds
• The period over which the funds will be accumulated
• The amount that can be earned off the accumulated funds
• The taxes on the income that is earned on the accumulated funds
• The desire and rate at which one would access and spend the actual proceeds themselves

Let’s look at an example of how this strategy would work out using the same business base assumptions we used for the example last week.  That assumption was your business has an average annual cash flow of $500,000 per year. Let’s do our calculation over a 10-year period with no growth in cash flow taking place over that period to be very conservative.

We are going to further assume that you 30% of your cash flow each year is available after taxes and reinvesting in your business.  That cash flow is going to earn 5% a year and be reinvested to create a compounding effect.  Finally when we are ready to sell the business we’ll invest the proceeds that have accumulated at 5% and pay a 25% tax rate on that income.

Annual cash flow from our business = $500,000

Annual cash flow invested = $150,000

Total accumulated after 10 Years with compounding = $1,886,682

The income earned on the accumulated savings = $94,334

The taxes on the income earned = $23,584

The after-tax cash to support your personal life style = $70,751

Now look at what this has done for your financial independence. Your annual after-tax cash to support personal lifestyle from the sale of the business was $70,313.  To that we now add the $70,751 from your long-term savings program for a total of $141,064, a doubling of your return on investment applied to financial independence!

This shows you the power of this strategy.  Of course no one has the same cash flow year in and year out.  But if you make cash flow distribution one of the primary goals of your business and build your strategy around it, you will be amazed and the amounts you can generate, distribute and accumulated.

But this is not all.  In my next post I’m going to show you yet another tool for driving your return on investment and financial independence up yet another notch.

Author Michael Podolny at Google+

Valuing a Small Business- Transferring Ownership to Financial Independence

Common Sense Strategies for Valuing a Small Business Higher

How Building Equity Translates to Financial Independence (Part 3 of 4)

We’ve been talking about a core goal of most business owners, earning a good return on their investment and having that contribute to their ability to achieve personal financial freedom.  We discussed that there are two ways of achieving a return on investment in a small, privately held business.  One can increase the overall equity value of the business and one can take a portion of the cash/profits produced each year by the business out and invest them.  These are not mutually exclusive.  In this post I will focus on how to use the underlying equity value of the business for contributing to personal financial independence.

For the value of the business’ equity to contribute to personal financial freedom there must be a mechanism for selling one’s equity, meaning that equity has to be turned into cash that can be invested in other assets.  This can be done via either an internal market (a succession/internal transaction) or the having the business sold to a third party. In calculating the ability of an equity sale to produce financial freedom, a number of variables need to be accounted for:

• The actual value that can be realized in an actual transaction (as opposed to the theoretical value from a valuation)
• The taxes that would be paid on the realized value
• The income that can be earned on the after-tax proceeds
• The taxes on the income that is earned on the proceeds
• The desire and rate at which one would access and spend the actual proceeds themselves

Here is a very simple example of how this might play out.  Let’s assume you have a business that has an average annual cash flow of $500,000 per year, that you can sell that business for 5 times its cash flow in an all cash transaction, that you will pay taxes of 25% on the proceeds of that transaction, that you can earn 5% on the proceeds, you have a 25% tax rate on that income, and you only want to use the income earned on the proceeds to fund your financial independence.

Transaction proceeds = $2,500,000

Taxes on the proceeds = $625,000

Net after tax proceeds that can be invested = $1,875,000

The income earned on the after tax proceeds = $93,750

The taxes on the income earned = $23,437

The after-tax cash to support your personal life style = $70,313

As you can see there are a lot of variables that need to be considered.  In addition to these other variables would be how much will you get from Social Security and when will you get them, do you have other assets, or do you have a retirement plan that you’ve been contributing to.

The key for you the business owner is to understand these variables and include them in your planning.  Forewarned is forearmed.  If you can do these analyses on your own so much the better.  But don’t be afraid to get help if you need it.  An owner can greatly increase their ability to increase their return on investment and achievement of financial independence just by understanding and slowly beginning to manage for these variables.

Author Michael Podolny at Google+

Valuing a Small Business-

Transferring Ownership to Financial Independence

Common Sense Strategies for Valuing a Small Business Higher

Understanding What’s Needed (Part 1 of 4)

Why does anyone make an investment? Presumably because they want to make money.  When one becomes a business owner, that person is making an investment.  Most business owners expect their investment to increase in value.  They tend to focus on the potential value increase as a primary benefit that should come from the investment.  They don’t always think about the income an investment could be spinning off – but they should.  The income producing capability of an investment is a major component to evaluating an investment.  Let’s call these concepts of increasing value and income produced from the investment Return on Investment.

Further, most business owners come a point in there life where they hope to not have to work, to be able to live on and enjoy the fruits of the investment into their business.  This means having a means to produce income that does not require working.  Let’s call this concept Financial Independence.

Return on Investment and Financial Independence are not the same things.  I can have a very nice return on my investment but if I don’t do certain things I won’t be able to achieve financial independence.  But the opposite is not the case.  It is highly unlikely as a business owner that I can achieve financial independence without getting a good return on my investment.   So an adequate return on investment is necessary for achieving financial independence but does not guarantee financial independence

In this series of blogs, I’m going to be discussing specific strategies you can use to ensure that you focus on return on investment and convert it into financial independence.  We’ll start by reviewing the heart and soul of value creation, profitability and cash flow.  Then we will look at the specific means one can use to convert that value to financial independence.

Author Michael Podolny at Google+

Creating Your Formula for Selling a Small Business

Creating Your Formula for Selling a Small Business

A Deeper Dive Into Improving the Drivers that Affect Business Value

Consistent Application of Accountability and Feedback Metrics (Part 4 of 4)

This month I’m covering specific things you can do in your business to increase its value, make it more salable and make it easier to do succession.  In this post I’ll be discussing the last of our four topics, the application of accountability and feedback metrics.

Oh accountability!  It is probably one of the attributes for improving performance owners least like dealing with.  I suspect this because it means they actually have to take action with their people and as I noted in the last post most don’t like doing that.  And accountability means that an owner might actually have to hold him or herself to that same standard too!

It’s one of those cruel little inconsistencies that advisers see in their clients all the time.  The owner wants everyone else to do the best job they can do but he or she is unwilling to do the unpleasant task of actually holding those same people or themselves accountable to the standards they claim they want seen done. (By the way don’t ask we advisers if apply these principles to our practices because we act just like our clients with our businesses!).  Like so many things in life – losing weight, getting into shape, trying to break a habit – it is a matter of personal commitment and will.  It’s also a matter of having the data/metrics you need to measure performance.

Let’s deal with the latter first.  Without objective data, it is extremely hard to make the accountability process work. Without data we are subject to opinions, feelings and impressions.  These are notoriously unreliable.  When there are measurements, it is much less emotional and subjective as to whether a goal is hit or not.  Not everything can be put into empirical measurement but a lot can and those are frequently important to the business’ overall performance.  Once one has measurements and metrics, one needs to look at them on a regular basis, and study their significance in the context of the overall business.

A simple form of accountability is tying behavior to measurements.  Sports offer an example.  If I’m a runner, I have time targets for the distances I’m competing in.  When I work out, I will have certain workouts I need to do…distance, speed, endurance, etc.  If I want to achieve my time performance goals, I have to hold myself accountable for both doing the workouts I have organized and for the performance targets I’ve set within those workouts. The same principle applies in business.  We set overall goals that can be measured, sales and profits for example.  We establish activities that need to be done – make sales calls, get out a certain number of proposals, produce a certain amount of product with a certain amount of labor, etc. – and targets that can be measured that show our progress in accomplishing those activities.  We review consistently, help those who are not hitting their targets, acknowledge those who do, and revise goals and measurements as experience shows you.

As with the preceding three topics, you can find whole books written on the subject of accountability and the use of metrics to drive performance in business and I doubt you have the time to become an expert.  So my advice is to start small and simple.  Find a few things that 1) are key to your business’ performance, 2) you have the data available for measurement, and 3) you can implement with only a few of your people including yourself.  Commit yourself to a regular time for analyzing what’s going on.  If you find that you are not hitting your targets, dig into why.  Set actions that can be taken get improvement.  Accountability should not just be holding people responsible but providing the analysis necessary to change actions and get the results desired.

Contact me at michael@podolny.com if you fell that accountability of the lack of it is something that is holding you back from building the business value you need.

Author Michael Podolny at Google+

Creating Your Formula for Selling a Small Business

Creating Your Formula for Selling a Small Business

A Deeper Dive Into Improving the Drivers that Affect Business Value

Repeatable Human Capital Development and Management (Part 3 of 4)

This month I’m covering specific things you can do in your business to increase its value, make it more salable and make it easier to do succession.  In this post I’ll be discussing the third of our four topics, repeatable human capital development and management. This subject is a subset of the sustainable business system we discussed in part one but in my opinion is so important it calls for individual attention.

Over my long career I couldn’t even count the number of times I’ve heard an owner say something like “I would love running this business if I just didn’t have to deal with all these employees.”  Do you feel that way?

Let me ask another question.  How well will your business perform and how much money will you make if all your people up and left?  It’s an exaggeration for effect.  Unless you are a one-person business, you can’t possibly operate your business without its people.  And if we’re honest with ourselves, our ability to achieve our goals is very near completely dependent upon how well our people do their jobs.  Yet when I assess businesses, it is rare that I find any type of systems for defining jobs and roles, for developing collaboration, for integrating the work of different departments, or for recruiting and training new talent.

This is on one hand is a bit of a mystery to me because there is a huge industry of advice givers, organizational development, human capital management, business coaches working at all organizational levels, etc., who specialize in helping businesses develop healthy, productive people processes.  On the other hand it is not mystery at all because most owners look at these disciplines and advisers as soft, fuzzy, and not ‘real’ business.

I’d suggest that if you’re in that camp, it would be in your own best interest to rethink your position.  When a buyer comes and values your business, he or she is going to look at how much your business is dependent on you.  Then they’re going to look how dependent it is on a small number of key people.  Then they’re going to see if the business can continuously develop the people necessary to produce the business results they want to buy.  If he or she finds you are the one driving all the performance, you will find you may not be salable at all.  If your business is driven by key people with no way to replace them, you may be a bit more marketable.  Only if you have the ability to continuously add, train, manage, and improve people, will you maximize your value and salability.

Are you ready to challenge yourself on this?  Contact me (michael@podolny.com) and let’s talk about what it might take.

Author Michael Podolny at Google+

Is My Business Salable?

Is My Business Salable?

Most business owners don’t ask the question, ‘Is My Business Salable?’ until they’re ready to sell – and may find the answer was not what they expected. Watch this video to find out what to do next: