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The Golden Rule: Entrepreneurship and enhanced business value

The paradigm facing many entrepreneurs is that, to enhance their business' value, they often have to create structure and measures -- the thing most thought they could leave behind to seek independence and fortune. Experience shows that business owners who can successfully grow with their business will retire with riches.

A business valuation analyst looks at every industry differently, as there are many unique characteristics that influence value. The total worth of a business can simply be expressed as adding all tangible and intangible assets together. But do business owners genuinely know how to optimize their businesses' values? Some do. Let's examine how.

Is it a service or retail business, a distribution or transportation business or is it a manufacturer? In the case of a service business, location in relation to other providers and likely clients may be a significant value driver. Or the provider may have created such a reputation that clients are indifferent to the business' distance because the service or product it provides is worth the distance premium. This might be the case for certain restaurants, bars and professionals. What of the manufacturer? Is the product so unique that distribution, material costs and a premium price are not the primary driver for the business?

A unique value proposition must be clear and defining. This is often the rarity that creates enormous value.

Let's examine how location drives several factors. What influence does the local population's demographics have on the success of a business? Ever notice where health food stores are and are not? Is the population growing or shrinking? Is it aging? Are they educated? Is there a university or hospital in close proximity? What are the average annual billings per employee in professional practices? What is the source of payment? Ask physicians whether they'd like wealthy patients or those who are receiving state insurance coverage.

What about employees? How far are they willing to travel? Is the optimum number of staff maintained during market cycles? Are they properly managed and compensated to assure low turnover? Are there mechanisms in place to keep key personnel from joining competitors or becoming a competitor? Does the local market provide adequately trained personnel? Are specialized skills and licenses required? What is the local unemployment rate? Would it make sense to operate multiple shifts and provide pay differentials? What is management's age, health, education, experience and roles/responsibilities? How is compensation being determined? Are there employee or partner agreements in place? If a key person was to become injured, incapacitated or die, how adversely would this be to the business' sustainable health? Is there adequate insurance and policies in place to mitigate loss? What influence do family members have on the culture of the organization? How heavily regulated is the industry?

What is the company's growth rate compared to its industry and market(s) served? How much are sales increasing as a result of higher pricing instead of increased units of sale? How do increasing margins impact the type and frequency of patrons? Does the company have a one-, three- or five-year plan it follows? Does it create a budget to fund the plan? How realistic are the assumptions and projections? Is the industry cyclical, and what factors influence these cycles? Is there a declining payoff to acquiring new clients, and what is the duration of time from awareness to a purchasing decision? This will differ considerably from a hospital acquiring a complex piece of equipment for its laboratory to a decision to purchase a sleeve of golf balls.

Who are the business' largest local, regional and national competitors? What type of customer is the company after? What levels of funds are allocated to business development? What is the ease and cost of entry into the market? The higher the barrier, the lower the level of new competition.

How mature is the industry? What is the level of innovation and technology, and their influence on growth of revenues and profits? Does the business enjoy unique strategic relationships with suppliers or other companies where integration or a joint venture allows for economies of scale or time savings? Is the business at a plateau unique to its industry that may require an infusion of funds or new talent to grow to the next level?

How long does it take for the "typical" company with a similar level of resources to achieve a certain level of sales? This is the ultimate time-value equation. Most companies seeking to penetrate a new market will determine whether it is more prudent to acquire a pre-existing competitor or take the estimated number of years to erode market share. Is market share being transferred from competitor to competitor or is a new market being created to provide for expansion? How much does it cost to retain a client versus replace one lost? How much is the average purchase? Are the purchasing habits seasonal or fickle like some types of retail?

Almost every company prides itself on how unique or superior its services are or how its pricing or delivery is competitive. What objective standard is it based upon? How genuinely aware is management of industry performance norms and the level of market presence? If there are unique aspects to the business model, products or services, are there any procedure manuals in place, patents, trademarks and/or copyrights? What do employees, customers, vendors, lenders and competitors think of the company, its people and its product or service? How does this impact repeat and referral business? Is the type of business one that has frequent need by repeat customers, such as grocery stores or gas stations, or are services annual, such as an accountant or dentist or doctor, or less frequent, such as tradesmen like plumbers or custom home builders?

Does the business rely heavily on inventory and equipment? How much influence do innovation and technology have, and are they being leveraged? What is the rate of obsolescence and lost clientele if service levels are inadequate or pricing fails to adjust to consumer expectations? Remember how quickly iPod pricing was adjusted downward after the first batch hit the market. Imagine what would have happened to the inventory if pricing had not been adjusted.

What is the turnover of inventory? How well does management leverage the use of lender funds? Does it adequately manage debt? How many assets are owned or financed that are non-operating, with no contributory value to an existing business? Will it require new equipment, personnel, space and/or funding to grow? Is the infrastructure in place? Does the company's legal structure lend itself to protecting its stakeholders while maximizing the economic benefits associated with its business operations?

What external factors are currently influencing the industry or company? Strong international competition has kept the relative price paid for a pair of jeans about the same for the past four decades, but hundreds of thousands of jobs have been lost due to higher manufacturing costs associated with higher wages.

What influence does energy have on pricing? Ask any restaurant owner or a building contractor, box manufacturer, newspaper or printer when the demand for wood and wood-based products exceeded supply.

Technology has allowed software programming, help desks and certain professional services like engineering design and tax return preparation to be performed elsewhere on the globe.

The level of taxes paid can influence where a business will be established, and may create competitive advantages for large companies that may require tax subsidies and exemptions.

The above items -- while in no way all-inclusive -- provide insight into every measure a business owner and a valuation analyst must consider to adequately quantify the level of risk associated with creating sustainable and transferable value. For every measure that meets or exceeds the norm, the value is likely higher. Conversely, creating a lifestyle may ensure a livelihood, but may not be sufficient to have an asset that one day could lead to a fulfilling and abundant retirement.

It seems evident that every step involved in running a business should include the question: How does this act or event impact the value of my business, and what do I need to do about it now?


Sheeler is a managing partner with Allison Appraisals & Assessments.

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