How Do You Determine The Value of A Business?  

Rodney Davis: You should understand the assets that you have in the business because when someone thinks about the ultimate future income from that business it includes the proceeds on the sale of assets.

So you should understand your balance sheet and understand how the things on your balance sheet can turn into cash in the future. Whether that’s the liquidation of your accounts receivable, offset by the extinguishment of your accounts payable, whether that’s the sale of tangible assets in a manufacturing business that might be a much bigger number, than say, in a services business, which you still may have tangible assets in the business. So you should understand your balance sheet when you’re trying to determine your current and your future exit value for a business.

And you should understand, not only the sources of income for your business, but also the strength, and the likely continuity of those sources of income, in the event that you were to exit. So going down a checklist, you look at your balance sheet, you look at where does my income come from, you look at the underlying cost of delivering those services normally. Because often when you look at the exit value of your business and you’re looking to sort of see what are the normal costs going forward. Obviously, people look at the historical cost, to get a sense of what the future cost might be, but you have to remove from those historical costs, those things that are non-recurring in nature.

So you may have one time put some personal expenses through your business. You want to take those out when considering future operating costs of the business. You may have incurred things to solve a problem in a particular year that are not likely to reoccur. You want to take those things out when you’re considering the future cost of the business.

How Do You Improve Your Company’s Value? 

Rodney Davis: So, some of the best things you could do, when you’re thinking about how do I enhance or maximize the value of my business, is try and ensure that there is a predictability to the future revenue of the business, there is a predictability to the cost structure of the business, there is a predictability to the working capital required in order to support that business. Because the more that that is predictable, and people have confidence that it’s reliable, the lower the risk premium they attach to the business, and therefore, the more they were willing to pay at the same level of earnings.

What About The Value That The Owner Brings To The Business?

Rodney Davis: Well, when we talk about the replaceability of the owner of a business, we’re talking about the difference between personal goodwill and business goodwill. People don’t pay a lot of money for personal goodwill, because personal goodwill isn’t necessarily transferable. So, if the business is totally dependent on you, then what good is it to me to come in and step into your shoes? If the clients are going to leave, upon your exit, then I’m not really buying that book of business.

So it’s really important that as a business owner, you try and establish business good will and you try and diminish personal good will. I mean, our egos make it hard to do, because the thought that our business could survive, or that we’re not the most important thing in our business, is something that’s hard to deal with, from an ego perspective. But it’s expensive to make your business continue to depend on you because other people aren’t willing to pay for that.

When Should Owners Start Planning Their Exit Strategy?  

Rodney Davis: You want to consider the potential opportunities for the business. You may be at a point where you just started a new business and it hasn’t had a chance to come into fruition so when you’re checking off sort of what’s my business worth. What’s the exit value of this business? You want to give thought to what it might look like tomorrow, in addition to what it looks like today, because there may be some underlying value that you might leave on the table that you don’t go through that checklist.

Every business eventually is going to require its owner to exit because businesses generally live longer than people. So if you’re operating in a business, no matter what stage you are in that business, every so often you should give thought to when, if and how you might want to exit that business, and whenever that inflection point comes along, make sure to think about value and think about what it is it needs to be done and whether you are doing the things that you need to do to maximize the value of the business, because it’s inevitable.

They say we’re born, we live, we die. Well, your businesses don’t follow that pattern, there are businesses that will live forever. There have been businesses that will forever, there are businesses that have been around for hundreds of years, they’ve outlived every owner they’ve ever had. There will be a time to talk about exit value, so just prepare ourselves for it.