Business Income or Business Value – More of the Story

If you are an owner of a small to mid-size business, the odds are that your business is what is sometimes called a “Life Style” business.  In other words, the business is there for an income with which you support yourself and family.  The more income you have, the better your lifestyle.

According to the Exit Planning Institute (EPI), most business owners have between 80 and 90 percent of their personal wealth tied up in their businesses.  Further:

  • About 63% of businesses are owned by Baby Boomers, and inevitably all of them will one day leave their business.
  • Of these, 83% have no plan for their future or the future of their business.
  • Half of these owners will need the business to be profitable after they exit.

Personal wealth does not come from revenue alone; it comes from the value of the business.  Value is linked to revenue.  You have to focus on BOTH to have the financial security to maintain your lifestyle.  So how do you do that?  (Business value also affects business loan eligibility and amount – that’s another story.)

To accomplish both, you have to understand several key facts about the business.  These are:

  • Understand how value is determined.
  • Understand how activities within your business affect your business value.
  • Know that you have to pay attention to your revenue and the value simultaneously.

A common issue for many business owners is that they confuse revenue with value.  Commonly the Business Owner is the source of much of the revenue, principally through the business owners efforts in either acquiring sales (revenue), performing the work, or providing the service that the revenue pays for.  The Business Owner becomes the business.  While many of these Business Owners started their business because they were the ones who could make the sale and do the work, this does not translate into the value of the business.  A simple question explains this – if you were to sell your business where you the Owner were responsible for the revenue what exactly are you selling?

I meet with many business owners who rightfully take great pride in their ability to bring revenue into the business or, who are experts at a trade, for example, can provide expert level product or service to a customer.  When the inevitable happens, and the business owner leaves the business (possibly through what the EPI calls the 5 D’s, Death, Disability, Divorce, Distress, Disagreement) the value of the business declines in proportion to what the Business Owner did or brought to the business.  In other words, if the Business Owner is responsible for 25% of the revenue or output of the business, then an immediate 25% decline in value could occur.

So what can a Business Owner do?  Even if the Business owner doesn’t plan on leaving the business for 10 or more years, what should they do to ensure both revenue and value occurs?  How can they create a lifetime income producing business?  Further, how can they create wealth and income for their family after they leave the business?

“…how can they create wealth and income for their family after they leave the business?”

It all starts with a plan.  The first step of which is what is the current value of your business.  Commonly this is calculated by multiplying your EBITDA (Earnings before interest, tax, depreciation, and amortization) by a multiplier that those who buy and sell businesses develop based on a variety of factors. Multipliers come from factors such as the size of your company, your industry, and other economic factors ranging from competition to trends within your industry in general. You can find a general idea of some of these multipliers here.

Most businesses focus strictly on what drives the revenue component of EBITDA.  You have to focus on what occurs after revenue and as a result, this will help you have some influence on the multiplier used to determine your business value.  To do this, you should:

Manage what drives your Cost of Goods Sold (COGS) such as:

  • Labor (Direct)
  • Inventory
  • Shipping and Handling

Manage your non-COGS business expenses

  • Assets
  • Expenses such as insurance
  • Non COGS labor (Indirect)

The Owner must also transition themselves out of a revenue-producing role as much as possible.  The reason for this was answered earlier when the Owner exits the business so does their value.  That value must and should be replaced before the Owner leaves.

Focusing on those areas that drive business performance is a key part of your efforts.  These are:

  • Operations/Process Improvement – understanding and managing –
    • Process Mapping
    • Cost Analysis
    • Workflow
    • Workforce Engagement
  • Production/Product
    • Pricing
    • Materials (inventory)
    • Cost of production
  • Marketing and Sales
  • Customer Service/Retention
  • Waste/Error Reduction and Elimination

This can’t be done in the same month you decide to try and sell or leave your business.  The sooner you begin this, the sooner you reap the benefit of those efforts.  Even if you aren’t planning on leaving your business anytime soon the value you gain puts money in your pocket for today and tomorrow.