When valuing a business, I will sometimes ask the business owner what he/she thinks the business is worth without the owner. This question will elicit various responses. Occasionally, the owner will look indignant and say something like, “What do you mean? I started this business, built it up over 20 years, and am responsible for its success! I am the heart and soul of the business!” The appropriate response to such a display (which I usually restrain myself from making) would be: “In that case, the business is not worth very much Mr./Mrs. Business Owner, because when you sell the business, you don’t go with it. It looks like the business does not have much value if someone else were the owner.” Business value really means transferable business value – value of the assets that can be transferred from one owner to the next. A business can be very profitable but not easily transferred.
This problem has many variations. A key employee (say a sales person) might be critical to the success of the business, but if that person does not have an employment contract and /or a non-compete agreement, there is nothing to prevent that employee from walking across the street to your competitor and taking with him/her a significant portion of the business value.
This issue appears in more subtle forms as well. Knowledge of certain sensitive production processes might reside with a few employees without being adequately documented. This could give a buyer pause. I was recently involved in the sale of a manufacturing business that had developed its own customized software that was not properly documented. The buyer refused to close until the seller brought in an outside consulting firm to clearly document the software.
Other systemic risks can reduce the value of otherwise profitable companies. A business with a high concentration in a few large customers will present a level of risk that many buyers will not be comfortable with.
The issue of transferable value often presents itself in the context of exit planning when the owner contemplates leaving the business. The problems that impede transferability can be solved if there is enough time. It could easily take 3 – 5 years to diversify a customer base or develop a management team that can run the business independent of the owner. This is one reason that it is important to plan for your exit from your business at least several years before the day you plan on retiring.
For additional information about transferable business value, check out this white paper on Value Drivers. Value Drivers White Paper 1.15.14
To request a consultation to find out what your business is worth, contact me at firstname.lastname@example.org.