The Value Builder Series
Helping business owners build valuable businesses
Through our Business Value Builder Programme we work with clients to build long-term value in their business. We help them by critically analysing their business to identify and leverage the key value drivers specific to them. This is part of a series of articles by Crowe partner Gerard O’Reilly that deal with a range of topics and challenges that owner-managed businesses face.
5 things that destroy a company’s value
Time and time again there are common mistakes made by business owners that can destroy value. Sadly, this can often happen when the owner believes they are doing entirely the right thing for their business.
1. Not converting profit into cash – poor working capital management
When a buyer buys a business the price they pay reflects their belief that they will recoup the investment in cash income plus a return on the investment. Even “born on the internet” businesses that lose money are ultimately expected to make it big. Google and Facebook only started to make profits in last 5 – 6 years. Equally the recent WeWork attempted floatation floundered because would-be investors don’t believe in the business model.
“Cash is not king”, says Karan Faridoon Bilimoria, founder of Cobra Beer, “it is Emperor.” This was after his own business, which he spent many years developing, fell victim to last credit crunch and had to be rescued.
However, time and again we see business owners carelessly reinvest profits in working capital. They believe they are improving the business when in fact they could be destroying value. A classic example of this is getting discounts from suppliers for payment upfront. A good idea most would say. However not from a potential buyer’s viewpoint. The commonly used formula in M&A deals these days is to value the business on a debt-free, cash-free basis at normal levels of working capital. So by paying quickly you have less cash and more working capital
As an example, imaging a business owner who is selling his business had reinvested €500,000 each year over three years in a greater stock range or in getting better terms. If they had not done so they would have €1.5m cash in the bank which they could have taken off the table at the time of sale, meaning their business value was increased by €1.5m. If however it is in stock then the buyer would maintain that the price they are paying for the business value reflects this greater stock range or better margin so to pay for the stock would be to pay twice for same business. Unless these moves have added €1.5m to business value through higher sales or profits then this strategy will have wasted cash.
2. Not converting profit into cash – excessive capital expenditure
What’s the difference between multiplying profits or multiplying EBITDA to get to the company value?
EBITDA is the general measure used these days as it best reflects the ability of a business to generate cash. However, it ignores depreciation which is an accounting attempt to measure the consumption of the fixed assets in the business over a period of time.
A typical adjustment that is made to this EBITDA is to account for recurring capital expenditure. This is the annual level of reinvestment needed to maintain the business capacity. If this is poorly-managed it will be seen as a leakage from the business the same as any other poorly-managed business expense.
This should not be confused with development capital which improves business efficiency or results in growth. However, the important measure here is relating this cost to the expected return. So if you spend €300,000 of a new machine that improves profit by €100,000 pa you have clearly made a wise investment.
3. “I know all my customers personally”
A proud boast of many business owners but a classic value destroyer.
So many businesses are proud of the personal service they deliver. Having key a close relationship with customer and delivering a unique experience brings them back. However, a business such as this is so dependent on each of those relationships and the bespoke nature of its service or product delivery that it is difficult to expand or to maintain these quality of relationships.
This issue is even more problematic when it is the business owner who is the key to these relationships. From a potential business buyer’s perspective, how can they be sure they won’t lose the business when you are no longer around?
4. Not developing a management team
Many business owners fail to develop their senior team, instead they keep tight control of all the key decisions. Not a bad formula for ensuring you maintain control and keep generating profit. But, from a potential buyer’s perspective, it is a problem. In most cases buyers want a business which will largely function on its own day-to-day, across operational departments like purchasing, sales and finance. Their opportunity lies where they can augment the business with capital, strategy and synergies.
Thus, a key job of the owners is to make themselves surplus to the day-to-day needs. They need to recruit the right people, make them accountable and empower them to make smart decisions.
5. A customised or bespoke offering
A common boast of many businesses is the bespoke customer service or product lines they offer. Customers love it – they get something unique, they become loyal, recommend you to other customers and in theory you make more money on each sale. Trouble is it takes a lot of effort. Each customer can also set their own terms of what they believe is great service or product. In this day and age this can lead to bad online reviews which can damage the brand.
In essence, a customised or bespoke offering is hard to maintain, difficult to teach and challenging to maintain a consistent quality of experience. Each sale has to be individually negotiated which can lead to uncertainty from the viewpoint of the potential buyer of your business. This is reflected in a lower multiple of earnings.
In summary, a business owner needs to have clarity of understanding of how they create value for a potential buyer. The flip side of this is avoiding the classic mistakes that destroy value.
Crowe partner Gerard O’Reilly manages our Business Value Builder Programme, a practical and effective programme for company owners to build lasting value in their business. Contact Gerry if you would like to find out how he can help you achieve your personal and business goals.
Read other articles in our Value Builder series:
Seven ways to create harmony in a family business