Dave figured his business would sell for five times his cash flow, or $5,000,000.
Not knowing enough to formulate an answer, I asked him to tell me more about his business and his role in it.
- Dave's company was a well-known consulting firm that designed and implemented management systems for medical practices.
- Dave's only role was to secure the consulting engagements while approximately 25 consultants (working in different locations around the U.S.) performed the actual consulting.
At first glance Dave's company was extremely valuable - consistent cash flow, great customers, and capable consultants. I asked Dave who would secure new engagements and manage the consultants after he left. Dave looked puzzled.
Dave explained that his consultants were not employees but independent contractors. Other than a part-time assistant, Dave was the only true employee and he had no plans to stick around for a year or more to train someone else to do his job.
It was my turn to do some explaining. "Dave, without you, there is no one to oversee projects or obtain them. Without you, your business is worthless."
The price Dave paid for not having developed transferable value was steep. As soon as the last engagement was complete, he shut down the company. With no transferable value, there were no buyers and Dave's income plummeted from $1 million to $0 overnight.
Is this an extreme example? It might be, but it is entirely accurate in illustrating how a company with consistent annual cash flow/EBITDA of $1,000,000 has absolutely no transferable value when no management team exists to replace the departing owner.
Can You Define Transferable Value?
Transferable value is what a business is worth, to someone else, without its current owner.
No matter which exit path an owner chooses, transferable value is the common denominator of a successful exit. Think about it:
- Why would insiders be willing to acquire a company (pledging personal assets) if they can't run the business without the current owner?
- If children are not capable of continuing a business successfully, passing it on to them is a recipe for disaster.
- Third-party buyers know that owners will be leaving the company when they sell it, so exactly what are they buying if the business is the owner?
- If the owner dies today, they cannot expect a business with no transferable value to provide their families any income.
- Without the ability to prosper without its owner, a business cannot help owners to achieve any of their value-based goals (e.g. preserving their legacies, maintaining their company's culture, and benefitting their communities).
Elements of Transferable Value
We refer to the characteristics buyers require and are willing to pay for as "value drivers". It is the strength of a company's value drivers that determines, in large measure, the value of a company. When they are present and functioning well, buyers will pay top dollar for a company because value drivers contribute to repeatable, sustained cash flow.
A company with strong value drivers can demand (and receive) a higher multiple on the same amount of EBITDA than can a company with average value drivers. Remember that if owners are vital to the success of their companies in any of these areas, then they have not built maximum transferable value.
Top Nine Value Drivers
- Next-Level Management
- Operating Systems Demonstrated to Increase Sustainability of Cash Flows
- Diversified Customer Base
- Proven Growth Strategy
- Recurring Revenue That Is Sustainable and Resistant to "Commoditization"
- Good and Improving Cash Flow
- Demonstrated Scalability
- Competitive Advantage
- Financial Foresight and Controls
Can This Wait?
Given that the sooner owners begin to improve their companies' value drivers, the more they benefit, why would you wait? If you wait to begin building transferable value until you are emotionally prepared to leave, there are several problems.
First, you still have to do all the same work necessary to build value. That work will take just as much time as if you start today, but once you reach your "I'm ready" point, there's a high probability that the passion and drive you had before that point will have evaporated.
Second, owners who wait to build transferable value forfeit years of increased cash flow.
Third, waiting owners also forfeit a better ownership experience. Why? Because the heart of increasing transferable value is making the owner replaceable while increasing cash flow. Ask yourself which tasks you find uninteresting or unpleasant and, if at all possible, transfer those to others first.
Finally, waiting to build transferable value until you feel ready to leave limits your exit path options and increases the difficulty of the obstacles you will encounter because you won't have the time to initiate alternative growth strategies.
Perhaps you aren't like Dave, the sole creator of value in your company. I'd be surprised, however, if you have a company that can run smoothly (permanently) without you. Installing and enhancing value drivers creates a company that can be transferred to another - without the owner - with minimal disruption to its cash flow. A successful Exit Plan cannot be created unless you build transferable value in your firm.
If your company or one of your clients may benefit by our experience and knowledge, or for a complimentary consultation please contact:
Russell Slappey 407.448.1781
rslappey@npcfo.com *Kevin is a licensed Certified Public Accountant (CPA) in the State of Indiana (Inactive)
Credit to John Brown at the Business Enterprise Institute, Inc. for contributions to this article.
What is the most important element in an owner's successful exit from their business? 