In a recent study by the Exit Planning Institute, 99% of middle-market business owners indicated that exit planning was important.  However, only 20% of these same business owners had a written plan in place.  In a recent panel discussion, one of my fellow panelists who had successfully exited his business said, “I wanted to run my business as if I could hold onto it forever or transition out of it tomorrow.”  Very wise words and, likely, what allowed him to exit successfully. 

Although, like having a will, having an exit plan is important, it is even more important to build a company that is a transferrable business.  A business needs to be built in a way that is attractive to market buyers and, the more attractive the business, the more potential buyers it will attract and the higher the value.  It’s really no different than the concept of selling a home.  According to US Housing and Urban Development, staged homes sell for nearly 20% more than non-staged homes and 87% of buyers said that staging made a difference in their buying decision.  Businesses are no different, but what does that mean for a business owner? 

In speaking engagements with entrepreneurial groups, I present a highly overly simplified formula for the factors impacting value.  Although it is a simplified version, I have yet to have a professional accountant, valuation specialist, or investment banker argue the formula’s accuracy.  The formula consists of the following:

Past growth/profitability + the platform for future growth/profitability – Risk = VALUATION

The “risk” element of the formula is essentially a catch-all and can encompass factors such as risk of loss of key customers or employees, contract risk, concentration of revenue risk, reliability of financials, sustainability of the management team, and the like.  When a business has a disproportionately high risk, the negative impact on the valuation can be extremely severe and, in fact, can scare away all potential buyers.  However, the business risk profile is not why buyers pay a premium for businesses. 

The first two elements of the equation are directly correlated to the effectiveness of the revenue function and its alignment with the strategy and financial modeling of the company.  Much like college athletes in a professional sports draft, the teams selecting the athletes want to see a history of performance and, more importantly, they want to see the potential future upside of their selected player.  They are betting on the future, and the more certainty there is about the future performance, the higher that athlete will get selected and the more money they will be paid.  This is precisely why professional sports teams have placed a high degree of value on the statistical analysis around factors such as speed, strength, jumping ability and mental acuity.  Does the athlete have the “platform” that will give them the highest probability for success. 

A business buyer, whether they be a private equity firm, family office, or strategic acquirer, looks at the field of potential targets in much the same way.  Your business has competitors they could also buy, so why is your business different in its market niche, customer base, value proposition, revenue model, or growth potential than your competitors and, therefore, would they be inclined to pay a premium, or a lower than market value?  This is why it is imperative for business owners to fully understand where, how and with whom is NET PROFIT created for the company and align its assets around its specific customers, targets, products, services, and people that drive the highest level of NET profitability for the company.  It is also extremely important that the organization understand the concept of opportunity cost and avoid investing time, energy, resources, and money in products, customers, or people who are creating less than acceptable return on investment, or even losing the company money. 

While top line revenue is important, bottom-line profitability is more important! Developing strategy and setting goals before fully understanding your company’s financial model will likely only yield more complexity and inefficiency with little incremental net profit or value accretion.