Building Business Equity

 

How to Create More Value

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A s a leader and/or owner in your company, part of your focus is to build equity for your brand and consistently build value in your organization. In this edition of Recipes for Success, we will look at the factors that influence the equity in your company and thus define success in your role.

BUSINESS EQUITY DEFINED

Business equity is the value you could sell or transfer your business for minus any debt owed on the business. Therefore, increasing the valuation or paying down debt both build equity.

While you should be able to review your business' balance sheet and identify the total debt, the value is another matter. It can be more complex to discern and track.

Here's how you can identify the current value of your business and the influenceable factors that will build business equity.

VALUATION PROCESS OVERVIEW FOR A PRIVATELY HELD SMALL/MID-SIZED BUSINESS  

Since our purpose is growing equity, we will not address minority/majority interest adjustments or other factors in valuing for a purpose other than an eventual sale.  

Here is a point of beginning for knowing your business' value:

  • Asset approach – Considers all assets on the company balance sheet with some possible adjustments

  • Market approach – Considers the recent sale of similar businesses

  • Income approach – Considers cash flows and multiples

Some industries tend to use a valuation based on multiples. There are a number of definitions for those multiples.

In addition to revenues over a particular period, such as the prior 12 months, other revenue factors that may be considered include: 

  • Company financial risk

  • Operational risks

  • Profitability trend

  • Recurring revenues

  • Uncollectible receivables

  • Profit margins

  • Client/Customer concentration

  • Client/Customer demographics

  • Product concentration

  • Copyrights and patents

  • Market concentration

  • Competitive position

  • Inventories

  • Transferable contracts

  • Quality and plan of management team

  • Quality and plan of staff


While there is a multitude of both general and industry-specific business valuation services available online, having someone who is an expert in your industry and geographically familiar with your business may be preferable. 

Using a valuation process to update your net worth, prepare a buy-sell agreement and your estate planning is all worthwhile. Our purpose here is to identify contributors to value and focus on designing a business plan which builds both profitability and value over the long term.



STRATEGIES TO GROW BUSINESS EQUITY

Once you determine the current value of the business, even if the current value is zero, look at the process and factors used to create the valuation. From the potential examples used, you can incorporate strategies that will strengthen your business, increase profits and grow equity.  

So how can you begin designing a strategy that maximizes your value at the time you are hoping to exit the business?

For example, let's assume your business would be valued at 6 x net profits for the prior year. If you were to spend $20,000 on new technology, perhaps, computers, and that was all deducted in that year as an expense, you would have just lost $20,000 x 6 of value for a total of $120,000 lost value.

But, if you had made this investment a couple years earlier and it resulted in greater profitability of $20,000 the year prior to the sale, you would have actually increased the value by $40,000 x 6 for a total of $240,000 in value gained.

If you have uncollectible receivables, you can reallocate resources that will reduce this trend. If you are experiencing price compressions in one area of your business, you can focus on growing the higher profit margin segment of the business. If your contracts are not transferable to a new owner, you may want to redraft contracts to be used in the future. This will play out differently for each business.  

What's Next? 

While this thought process seems logical, many business owners get stuck in the weeds of everyday business demands. That is why setting aside time to go through this exercise can be just the thing you need.  

Once you identify the current value and factors that will build equity for your company, incorporate the appropriate strategies into your business plan. 
 
We are here to support you through this process. Email Kris Hartland to schedule your free 30-minute Building Business Equity Consultation.

About the Author

Kris Hartland, CFP®, CFS®, CEBS, EA
Associate Business Consultant

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Business ManagementKristine Hartland, CFP®, CFS®, CEBS, EA