Transferable business value is determined not by how well you run the business, but by how well the business runs without you.
Transferable value in a closely held business is most simply what that business is worth to someone else without its current owner. Transferable value is often confused with profit but just because your company is profitable does not necessarily mean it has transferable value.
Transferable Value Is More Than a Formula.
Business owners aren’t always aware that transferable value is more than a formula involving multiples of earnings or some calculation of discounted future cash flows. To calculate of your company’s current transferable value, we suggest that you start by asking yourself two questions:
- If you left your business today—for good—could your management team continue with minimal disruption to its cash flow?
- Do the members of your management team have an incentive to say should you exit?
Value Drivers Impact Transferable Value
To assess your company’s transferable value, start by evaluating its value drivers. Installing, assessing their effectiveness and enhancing them can help create a company that buyers (e.g., next-generation family members, key employees or outside third parties) want because they can run it with minimal disruption to cash flow. Some examples of value drivers that you may need to focus on include:
- Steady and improving cash flow
- A stable, motivated management team
- Operating systems that improve the sustainability of cash flow
- A solid, diverse customer base
- A realistic growth strategy
- Financial foresight and controls
One might measure the effectiveness of value drivers by:
- Their positive contribution to cash flow.
- Their ability to continue to contribute to cash flow under new ownership.
A company with strong value drivers can demand (and receive) a higher multiple on the same amount of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) than a company with weak or non- existent value drivers.
Use Your Management Team to Build Transferable Value.
It’s one thing to understand what value drivers are, and another to successfully implement them. By definition, the responsibility for implementing value drivers cannot be yours alone. Look again at the list. At the top of it is next-level management because your team plays a huge role in implementing the other items on the list.
We’ll admit that building a management team that can check off all the value-driver boxes and is fully capable of running your company without you can be challenging. We know, however, that doing so is essential to creating and preserving business value.
As Owner-Based Planning Advisors our “mantra” for owners is simply:Transferable business value is determined not by how well you run the business, but by how well the business runs without you.
Next-Level Management
A next-level management team is able and motivated to maintain and grow the value of a business. Putting a team in place before you are ready to exit gives a team the time and opportunities to prove its ability.
Attracting the right team is the first step, retaining it long-term and motivating its members to grow cash flow at the pace you desire (or need) is the no-less-important second step. The most effective way to motivate and retain next-level managers is provide an incentive.
Incentives for Next-Level Management
Creating an effective incentive plan that rewards members of a management team for achieving growth goals that you set is the best way to keep it in place and motivated to increase business value after your departure. How we can help A substantial part of our Owner-Based Planning practice is focused on helping owners like you increase cash flow year over year. We can recommend variety of tools to help businesses motivate and retain next-level managers. Examples include performance based cash or stock bonuses, Non-Qualified Deferred Compensation Plans, Phantom Stock Plans, Stock Appreciation Rights Plans, options to purchase ownership, incremental sale of non-voting stock, etc. Most of these plans include vesting provisions to encourage your key people to perform and stay with the company for the long term.
The underlying premise in designing and using any incentive plan is to motivate your key employees to increase the cash flow and value of your company at the pace you deem necessary to achieve your goals and aspirations for you, your family, and your business.
We are here to Help!
We strive to help business owners identify and prioritize their objectives with respect to their business, their employees, and their families. If you are ready to talk about your goals for the future and get insights into how you might achieve those goals, we’d be happy to sit down and talk with you. Please feel free to contact us at your convenience.
The information contained in this article is general in nature and is not legal, tax or financial advice. For information regarding your particular situation, contact an attorney or a tax or financial professional. The information in this newsletter is provided with the understanding that it does not render legal, accounting, tax or financial advice. In specific cases, clients should consult their legal, accounting, tax or financial professional. This article is not intended to give advice or to represent our firm as being qualified to give advice in all areas of professional services. Business Enterprise Institute, Inc. is a discipline that typically requires the collaboration of multiple professional advisors. To the extent that our firm does not have the expertise required on a particular matter, we will always work closely with you to help you gain access to the resources and professional advice that you need.
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Any examples provided are hypothetical and for illustrative purposes only. Examples include fictitious names and do not represent any particular person or entity.
