Think the equity value of your business is something you only need to worry about if you’re planning to sell? Phil Ives disagrees.
In his Vistage webinar the rapid growth business expert debunks the common misconceptions around business equity, and clarifies why everyone – irrespective of whether they’re thinking of selling or not – needs to implement an equity value strategy.
“Most of the time when a business owner says they want to sell their business, they find out they’ve got a couple of years’ worth of work to do,” Phil says.
Of course, this becomes even more critical when you place it in the context of the current climate. Here’s a little taste of what you can expect from the webinar...
The truth about equity value
When we think about what a business is worth, the first (or only) thing most people focus on is profit. While profit is a factor, Phil is quick to explain why it’s only the tip of the iceberg:
“Business owners are much more able to influence what their business is worth than they believe. The common belief is that your business is only worth what someone will pay for it. That’s true to an extent but it’s also about being on the front foot - that can be worth a fortune to people.”
This idea of business value being fixed and determined by profit is often based on the standard accounting ‘valuation formula’: Profit x a multiple (fixed and based on industry). Phil is clear on what he thinks about this.
“It’s just not true. If you ask an accountant what the multiple is for recruitment, they’ll say ‘6’. They miss the fact that when you get into a transaction, you’re highly unlikely to end up with a multiple of 6. In reality, there’s a range of multiples between 3 and 12, and 6 is the average.”
“An accountant will see factors which have brought the value down, but almost nobody has any understanding of the elements of the business that increase the multiple above and beyond that average or benchmark.”
So, if profit isn’t the only factor, and industry multiples are not by any means fixed, what does impact on equity value?
The risk factors
In a nutshell, it’s all about risk – or rather, reducing risk. Businesses which have innovative and dependable systems, structures and processes in place are often the most valuable to investors. This is because they’ve effectively been built on solid ground. You may have big profits, but what do those profits rely on? If your CEO is the “Chief Everything Officer”, as Phil puts it, what happens if they leave? In short: how can you demonstrate that your business is future-proof?
There are six perceived risk areas which can drastically affect the equity value of your business. Topping the list, says Phil, is your management team.
“One thing investors invariably complain about – particularly in SMEs – is too much dependency on the CEO. Another thing is a lack of succession or a lack of capability. Investors will certainly spot if there’s not enough experience in the management team to take the business up to the next level of growth. These are all things that cause investors to say that a business is full of risk. Issues around the management team can destroy the multiple by a factor of about 50%.”
Another significant area of risk is revenue. To a large extent, the types of revenue streams you have and how they’re structured is of more interest to investors than how much revenue is coming in.
“A business that hasn’t systemised how it generates revenue and ends up being dependent on too few clients or too few salespeople will be seen as higher risk. I’ve seen companies where 80% of their revenue is coming from two clients – which is disastrous if one of those clients were to disappear.”
“Liabilities are another area of risk”, Phil explains. “This can include things like having a pipeline of HR tribunals ahead of you or partners who haven’t exited the business cleanly. Sometimes, crazy things, like the fact that your business hasn’t had a PAYE audit for the past eight years, can cause a deal not to happen at all.”
The right kind of strategy
Phil is clear that mitigating these risks isn’t about short-term troubleshooting, but rather long-term strategy.
“Increasing the equity value of your business comes down to having a strategy around your multiple as well as a strategy around your profit. Most businesses have a profit strategy but no idea what a multiple strategy looks like.”
Despite this fact, Phil notes that business owners may be pleasantly surprised when they do start to think about their multiple strategy.
“This is the energising bit. Business owners might find there’s some element of their business which they view simply as something they need to run their business. But to somebody else, it’s a significant off-balance sheet asset. You might have a way of doing things, a process, IP, which is of great value to investors.”
For example, recently I met with a business that sells cheese - they sell £33 million worth of cheese every year,” Phil says. “The CEO calls it a ‘cheese business’.
“But it’s not really a cheese business at all, it’s a distribution business. He’s found a way of distributing an awful lot of food around the country - the fact that it’s cheese is irrelevant. It could be anything. An acquirer wouldn’t be interested in the cheese element, they'd be interested in the systems and processes he’s got for selling food and distributing it at scale around the country. That makes it a very different conversation at the valuation stage.”
If Phil’s points have piqued your interest, you can learn more strategies about increasing the equity of your business in Phil’s full webinar here.
Image: By YiuCheung Via Adobe Stock