Driving Your Company's Value

Simple (but fair?) Valuation Methods

One of the key components to any buy-sell agreement is the valuation method employed.  How will the business, or an ownership interest in the business, be valued for purposes of executing a transaction governed by the buy-sell agreement?

Two valuation methods exist that I will refer to as "simple" valuation methods.  The first of these methods is the fixed price method, whereby the owners agree in advance what the valuation will be.  Simple? Yes.  Accurate? Probably not.  Things change daily in business, and that usually means the value of the business is frequently changing.  The day after a fixed price is agreed to, events could occur that render that value worthless.

Another "simple" valuation method is to use a pre-defined formula.  For example, "the value of the business will be equal to annual revenue times three."  This method isn't quite as simple as a fixed price, but is not far from it.  Accurate? Possibly.  Fair? Hard to say.

Let's consider a situation that could be problematic.  Let's say a company formed another business unit that Shareholder A ran by themselves with no input or involvement from Shareholder B.  Further, let's assume this business unit and its financial results are not reported separately, where it would be easy to carve this business unit out for purposes of applying the formula.  The real question is, though, should the unit and its financial results even be considered if Shareholder B were being bought out?  Chances are the two shareholders would have different views of this.  Unfortunately, our simple formula provides no guidance in a situation like this.

Simple methods of valuation achieve many desirable objectives.  But if the overriding objective of your buy-sell agreement is fairness to all owners, these methods may not achieve the goal.

Disciplines of the Entrepreneur: The Enterprise Leader

According to Michael Gerber, author of E-Myth Mastery, there are seven disciplines that a successful entrepreneur must develop to build a World Class Company. Each discipline is like a puzzle piece that makes up the enterprise. Each discipline is like a puzzle piece that makes up the enterprise. It’s not a building block working in a linear fashion, but rather part of a system of components that work together to complete the whole that make up the company. The entrepreneur must have all disciplines regardless of the size of the company in order to achieve his or her desired objective, the vision of what he or she is trying to create.

The seven disciplines are: 

1. The Enterprise Leader
2. The Marketing Leader
3. The Financial Leader
4. The Management Leader
5. The Client Fulfillment Leader
6. The Lead Conversion Leader
7. The Lead Generation Leader

There are five essential skills the Enterprise Leader must have

Concentration, Discrimination, Organization, Innovation and Communication. The skill of Concentration is learning to feel comfortable with being a lone. We’ve heard the phrase, “It’s lonely at the top.” It’s true. The entrepreneur is the final decision-maker. Good or bad, your decisions are the ones that will create the company of your dreams. As the enterprise leader, your work is to lead, not do. According to Gerber in his book E-Myth Mastery, you need to remind yourself every day, “I am a leader. My job is to do the work of leadership.” This skill deals with how to focus your attention. 

The second skill, Discrimination, deals with where to focus your attention. You need to learn how to choose between alternatives. The most important things for an enterprise leader to consider are the vision, mission and values (the culture or consciousness) of your enterprise. Focus on the end game of what you’re trying to create. Every option or path you choose to pursue should be held up against those elements. Ask the question, “will this path get me to the vision I’m trying to create? Does it tie into the mission of what we’re doing?”

The third skill, Organization, deals with the functional components of your enterprise. This is how you organize your business, turn chaos into order, how you structure your business so everything has a place and function and it works in an orderly fashion.   

Innovation, the fourth skill, depends on Discrimination. Everything you do must be held up against the standards of you vision, mission and values. Performance is judged by the standards of how well it contributes to achieving the future objective of the enterprise. Innovation comes from following a series of steps that include determining what you want to improve, deciding how to improve it, quantifying the improvement or its effect on the enterprise, testing it, and re-quantifying, and testing it again and again, until you get positive results.

The fifth skill is Communication. This involves how you communicate to
your people what you expect of them, how you listen to their understanding of your expectations, and how you improve your communication to close the gap between your expectations and their understanding of them. Organize your communication so it’s clear, compelling and inspiring. Present it in a variety of ways, in person, via e-mail, in newsletters, on the website, in brochures and other marketing materials.

Resource for In-Depth Information on Buy-Sell Agreements

For those of you who are really interested in the topic of buy-sell agreements, let me direct you to a wonderful source of information.  Chris Mercer, founder and Chief Executive Officer of Mercer Capital, has written a great book entitled Buy-Sell Agreements: Ticking Time Bombs or Reasonable Resolutions?  The book covers a wide range of topics and considerations for forming and executing effective buy-sell agreements. 

Learn more about the book at:

http://www.mercercapital.com/index.cfm?action=page&id=273

Quantify Your Business

Once you’ve developed the vision, mission and values for your business, you need to measure it. Walking around and talking to your staff is good, but it’s not enough. According to Michael Gerber in his book, E-Myth Mastery, by creating an effective quantification process, you can pinpoint what’s happening in your business and anticipate when problems might occur that need to be corrected. This results in an agile business, able to adapt to change quickly. Just make sure you’re quantifying relevant information that affects the growth and sustainability of your business.

There are three levels of key indicators that need to be addressed, according to Gerber:

Strategic –  which show how the business is progressing towards achieving that future vision.

Business –  which enable you as the CEO and your senior staff to view the business and its major divisions or departments as an integrated whole, and

System –  which show managers and staff at all levels, in detail, what is right or wrong with each system within the organization.

Key Strategic Indicators
These indicators give you a sense of the overall morale and health of the organization. They are high level indicators which tell you whether or not you’re still on the right path towards your desired outcomes. At the strategic level, these may include employee satisfaction, customer satisfaction, market positioning vs. your competition, and profitability vs. revenue.

Key Business Indicators
These tell you how well each system is working together. Remember, a business is a set of systems within an overall system (the business). There’s the IT System, the Marketing System, the HR System, etc. Even if you’re a small business with fewer than five people, you can divide your business into systems. You need to be looking at how well integrated these systems and processes are, how well they work together, not just at the individual parts of the business. Some indicators will be financial, some will be around customer service or product marketing, sales or lead generation, and some may focus on technology, production or manufacturing.

Key System Indicators
Here’s where you get into the detail of each system and measure and track what’s working well and what isn’t. Identify the key indicators in each system that make it successful and a plan for each to achieve that level of success.

Set up a process to gather the information and report it on a monthly and quarterly basis. This keeps you focused on the whole business and its integrated parts. We recommend simple tools that result in one-page reports. They don’t need to be lengthy, but the reports need to be relevant.

Every Business Needs a Plan

      Every business needs a plan. We suggest starting with a 3-to-5 year strategic plan and building your annual business plan(s) under that. However, if you’re looking for additional capital or seeking investors, most investors expect to see a 3-year business plan. In his book, E-Myth Mastery, Michael Gerber describes “The Business Plan That Always Works”.    

    He suggests, starting with a “heart-felt” planning process, with what’s important to you, the business owner. Whatever you’re creating has to be something you feel passionately about. Document that in your plan, otherwise, if there is no passion, it’s just another plan that probably won’t be used. You’ll have to use educated guesswork in your plan because it’s hard to predict the future. But with the right research into areas that may impact your company’s direction, you can have a fairly good idea of the changes that may be ahead.

    One key component is to build change into the business plan. Your plan is not a rigid document that once completed, sits on a shelf somewhere. Look at it as a framework for your business growth. Put all the elements in a 3-ring binder that can be updated on a regular basis. Once you’ve written your plan, set a time to review it with your executive team (if you have one) or by yourself or with a business advisor, on a monthly or at least a quarterly basis. This will keep it current. If opportunities arise that aren’t in the plan, add them to the plan and pursue them…if they make sense for the business and will help get you to your future goal. 

    If you have staff, include them in the process.It's important that everyone has ownership of their piece of the plan. That generates buy-in and commitment when you implement the plan.

Benchmarks for Producing Your Business Plan 

• Create A Mental Picture Of Your Business Plan’s Impact.
  What would it feel like to have your plan work? Picture it in your mind. Better yet, gather images that reflect this “dream” and put them on paper to create a visual map of your future.
• Outline Your Business Plan.
  This becomes the table of contents for you plan to help you organize the elements.
• Prepare Your Business Plan Binder.
  Assemble everything in a three-ring binder with tabs for each section. This allows you to change the plan as you go along.
• Gather Materials You Already Have.
  If you’ve been in business awile, you should have a fair amount of documentation (financials, marketing and customer data, product information, etc.). Decide if each piece is complete as is, or needs to be revised, and put it in this section.
  
• Identify What You Need To Produce.
  Also include who needs to provide them and where to get the materials.
  
• Conduct Planning Meeting.
  Gather your executive team (or if you’re a small business, all your staff) and enroll them in the process. Paint the picture of what you’re trying to create, and ask for their help and support. Listen to what they say. End the meeting with a clear understanding of who will do what by when.
• Prepare, Review, and Revise Materials.
  This is the tactical part of the plan. Reivew each piece of information your team provides to ensure it’s relevant and that each piece works together with the other pieces to achieve the future vision. If they need further analysis or revision, send the materials back to the teams or individuals for revision and review them again.
• Produce “Final” Plan.
  Put it all together and give your plan a polished, easy-to-read appearance. Reduce it down to a two-sided, one-page document that each person can have handy as a reminder of what the business is trying to accomplish.
• Create Change Mechanism.
  Set follow-up meetings on everyone’s calendar to review the plan and make necessary changes as you go along. This is critical to ensuring that you are able to adapt to change as it occurs and keep your business on course.

    

Cash Flow Management Checklist – Part 1 of 7

There are many ways to work on improving your cash flows.  They can be organized into groups related to the various aspects of your business.  This series of posts will list actions you can take related to seven areas of your business.  They are:

1. Sales
2. Operations
3. Credit Management
4. Purchasing
5. Inventory
6. Capital Investments
7. Capital Structure (debt and equity)

Sales related cash flow improvement actions include:

• Increase sales – increased cash sales will provide the most immediate boost to cash flow.
• Increase prices – consider increases to only slow payers to offset your financing and collection costs with their slow pay.
• Bring the sales force into discussions related to customer pay performance – consider sales incentives related to a customers’ pay performance.
• Improve your credit granting procedures when accepting new customers
• Modify your sales agreements to require deposits (retainers) or multiple payments over the sales/collection cycle.
• Reduce the credit payment period granted to customers. – use care as being too restrictive can also reduce overall sales.