GT Succeeding at succession: establishing the value of your company Canada
Succeeding at succession: establishingthe value of your companyNovember 2011In a recovering economy, listing. It is even true if you have yet to to assess business value. Income approaches, articulate your succession planning goals. for instance, calculate a discounted cashsuccession planning is rarely That’s because the establishment of a flow (which uses projected financialtop of mind for business sustainable business model can help you performance to evaluate how a companyowners. More often, privately achieve a wide range of business and will perform over time) to determine the personal objectives—from maximizing the net present value of a business. Asset-basedheld businesses—which sale price of your business, minimizing approaches determine value by adding theinclude family enterprises, taxes and creating ownership opportunities sum of the parts of the business to arrive atinvestor- and entrepreneur- for key employees, to maintaining an a net asset value. There are also market- ongoing role in the business, sharing in based approaches that determine value byowned businesses and future growth or leaving a lasting legacy. comparing a business to similar companiesprofessional firms—focus Value enhancement also plays a critical within its industry.on enhancing cash flow, role in succession planning. To structure a While these represent the primaryreducing costs and managing tax efficient exit, set up a funding approaches to business valuation, mechanism for successors, justify future variations exist depending on the contextday-to-day operations. cash flow projections or maximize the for the valuation (e.g., financial statement proceeds of a sale, you need to establish reporting, tax planning or transactionalOn some level, this focus on short-term the value of your business. In essence, purposes). Valuators also typically take asurvival makes sense. After all, according understanding your value drivers is the wide range of factors into account whento a Grant Thornton International first step to reaching your succession establishing value, including:Business Report (IBR), 49% of planning goals—whether you intend to • financial history and business forecastsorganizations have seen a shortage of keep the business in the family, transition • industry and market trendsorders and reduced demand.1 Yet, despite to management or sell to a third party. • management structure and skillsseeming logical, this type of approach puts • tangible assets, including real estateprivately held businesses at risk of being Arriving at the magic number • intangible assets, including goodwill,blindsided by the future. Given the importance of value to strategic supplier relationships, name To avoid this risk, you need more than decision making and to succession planning, recognition, patents and trademarks,a short-term plan. You also must lay the one would imagine that every business proprietary technology, etc.foundation for long-term growth by owner would know the value of theirstrengthening the value of your business. company at any point in time. However, Notably, each valuation approach is likelyThis is true whether you aim to pass the that isn’t always the case. This is partly to establish a different value for thebusiness on to the next generation or you because arriving at business value is as business, and each of those values wouldplan to sell, merge or pursue a public much an art as a science. be correct. This is where the “art” of At the “scientific” end of the equation, business valuation comes in; where value Grant Thornton International Ltd, International Business1 professional valuators use various methods becomes the price the market will bear; Report 2009, www.internationalbusinessreport.com
where a willing buyer and a willing seller trimming expenses, strengthening internal find equilibrium. processes, introducing new products, For instance, if you plan to sell your expanding to new markets or investing business to a third party, it’s likely you in other strategies to drive profits, growth will want to maximize the sale price. To and sales. Each of these is important accomplish this, you need to present a regardless of the strategic succession compelling vision of what the business objectives. could become under someone else’s In short, business owners need to ownership rather than a historical think about their ownership in the perspective of how you arrived at the business in the same way they would current state. You then need to generate consider any other investment they hold— competition among potential buyers and by maximizing the value of this asset tap into the intangible emotion that comes according to their income or growth with a bidding process—the fear of losing. requirements.“To maximize profits and A compelling story and competing bidders Keep in mind, too, that there arevalue upon a succession, are more likely to result in a price that is tradeoffs to make. One business owner significantly above any scientific value. may value the continued health of theprivately held businesses Conversely, if you are transitioning to company and the happiness of theshould start planning for a family member or employee, you may workforce to such an extent that he orsuccession several years in prefer a valuation that reflects what the she is willing to take less money out upon business and your successors can afford. retirement. Another owner might placeadvance. Don’t wait for a Too high a valuation may hamper their such a premium on maintaining familyyear of super profits, or a ability to buy into the business. Too low management of the business that he oryear of weak performance, a valuation may leave exiting shareholders she might pass over more qualified without sufficient future cash flow. successors—a decision that can affect theto plan an exit. Start early, As both of these cases make clear, long-term value, profitability and viabilityso you can transition on valuation is not an exercise that should of the business. Given these variables, it’syour own terms, while you be confined to estate planning or sale no surprise that many privately held scenarios. Instead, owners of privately business owners lack a clear understandingare in control.” held businesses need to understand how of their organization’s value or valueKay Gray their value drivers can affect both short- drivers.Grant Thornton LLP, Canada and long-term performance and take the necessary steps to enhance the viability of Understanding your value drivers the business over time, and both improve In any strategic process, it is essential for and preserve its value. This could include business owners to understand the factors cleaning up your balance sheet, ensuring that enhance business value. When you have the right management in place, properly identified and managed, value
drivers can help you improve cash flows, that model in other locations or markets.attract investment capital, strengthen your Proven business models also help tocompensation structures and differentiate mitigate risk, which can improve value.yourself from the competition. Management and systems: Business Because these activities can shift value generally also hinges on the strengthbusiness value in a relatively short period of a company’s systems and a managementof time, it’s incumbent upon privately held team. Strength and depth of team beyondbusinesses to be aware of the elements that the founder can be critical.typically drive value: To strengthen these various valueTrack record: Business value is affected drivers, privately held businesses typicallyby a company’s history of sales, growth need to find ways to enhance cash flowand profitability. It also varies depending while minimising risk. Companies thaton a company’s cash flow and its profit hope to maximise value upon successionmargins relative to industry peers. should consider planning at least three to five years before a transition. For their “Leading business can oftenMarket factors: At any point in time, part, companies interested in growing the manage their value drivers tocertain sectors tend to be viewed withgreater importance than others. Your business over time would do well to improve cash flow and manage their value drivers on an ongoingbusiness’ value will be influenced by the minimize perceived risk. For basis – whether or not they have yetsector in which you operate, as well as developed a succession plan. example, running alternateyour ability to capture market share andcompete effectively. scenarios lets you focus on Maximising value: lessons learned the things you can controlValue proposition: Another driver of Once you understand your value drivers,value is a unique value proposition that you should be able to form an unbiased and be cognizant of theclearly sets you apart from your opinion of your organization’s value. In things you can’t control thatcompetition. It is worth noting that this reality, however, this rarely happens. you need to mitigate.”type of intangible value driver is very hard Business founders often link the value ofto replicate. their companies to the time and effort it Tony Markwell took to build the business, which Grant Thornton, AustraliaUnique assets/intellectual property: frequently results in an over-estimation ofOrganizations with an established brand, the company’s worth. This is also true ofpatents and/or proprietary technology or privately held business owners who haveprocesses can generally use these assets to received unsolicited bids, especially wheredrive value. they do not have a strategy for selling theBusiness model: Value typically varies business. In other cases, owners hesitate todepending on the strength of your commit to a firm value because they arebusiness model and your ability to adapt simply not ready to exit the business.
Despite these concerns, experience the company’s best interests and theshows that privately held businesses must owners’ best interests. In many cases,be nimble and strategic if they hope to businesses reach a point where theyachieve their succession planning goals. require additional capital just at a timeWith more than 30 years’ experience when shareholders are looking for ways tohelping privately held businesses establish reduce their personal risk. This tension canvalue upon succession, Grant Thornton make businesses vulnerable to valuehas learned several key lessons to foster destruction and threaten the company’ssuccess. long term viability. If you are experiencing this challenge,1. Know what to expect it’s important to decide on your priorities.Although succession planning specialists If the business is more valuable tohelp businesses transition to a new someone else than it is to you, it mayownership framework on a regular basis, be time to consider selling. If it is moremost business owners engage in successiononly once. As a result, many privately held valuable to you than to someone else, “There is never one value forbusiness owners do not know what to perhaps you should maximize current a business. Valuation shifts income and consider transitioning to theexpect upon exiting their business. next generation. Either way, keep in mind depending on its purpose – Owners may not understand how that your business is ultimately just one whether you’re setting up amuch after-tax cash flow they requireupon retirement. They may be unclear asset in your portfolio. By establishing charitable trust, determining value independently, you may gain theon how to compensate their employees outside perspective you need to decide if a remuneration structure orupon transition. If they feel successors lack you would prefer to hold or sell it. selling to a third party.sufficient training, they may worry aboutthe company’s future viability. If they are 3. Be honest about your weaknesses While value tends to fallengaging in a sale, they may be hesitant to Privately held businesses with a history of within a range, it can beshare sensitive information with potential strong performance tend to predict future different depending on thepurchasers or respond to extensive growth with reference to the past.information requests. For these reasons Unfortunately, this tendency can create a situation and goal.”and more, it’s important to work with false sense of invincibility. Because Bill Kingsleyexperienced professionals who can prepare independent succession planning Grant Thornton, United Statesyou for what to expect upon transition professionals look at your business with anso that you can meet your succession unbiased lens, they can often pinpointplanning goals. risks that threaten the company’s ongoing viability. For example, something you2. Decide on your priorities perceive as a strong customer relationshipAs privately held businesses mature, they can be viewed just as easily as a customermay begin to experience tension between
concentration risk, particularly if a 6. “Professionalise” the businesssignificant percentage of your sales are tied Yet another strategy for enhancing valueto this customer. upon succession involves putting systems Privately held businesses that heed this and processes in place to ensure yourwarning may be able to exit their business business runs as professionally as possible.on an upswing. Those that ignore the There are a range of activities to help youmessage, however, risk suffering an achieve this goal—including developing airretrievable loss of value. formal business plan, bolstering your management team and constituting an4. Recognise the power of innovation independent board of directors. YouAnyone who has established or built up a should also ensure that the businessbusiness understands that growth is rarely operates on a standalone basis byachieved without innovation—and implementing formalized and documentedinnovation requires some measure of risk. systems and processes. By working withTo ensure their organizations arepositioned to pursue growth opportunities professional advisers, you can identify the “The earlier you articulateas they arise, business owners should strategies and processes that can help you your strategic vision, the best emphasize value.adopt processes and systems that better it is for your businessencourage innovation and reward Helping you enhance value value. With a strong outlookmeasured risk taking within the context ofan enterprise risk management framework. Given current economic realities, privately for the future, you can avoid held businesses in all sectors are looking5. Strengthen your management team for ways to strengthen their performance. reacting to circumstancesOne way to strengthen business value is to That’s why it has become increasingly and instead can positionensure you have the strongest possible important to work with professional your business to reach itsmanagement team in place. If you plan to advisers who can help you understandscale back your involvement in the full potential.” how to control your value drivers.business, professional managers can Whether you would like to improve your Alejandro Chiappemaximize sustainability by running the cash flow, reduce business risk, strengthen Grant Thornton, Argentinabusiness in your absence. Strong business your internal controls, revise yourvalue can also help you attract and retain compensation structure or explore youressential management resources. In exit options, Grant Thornton LLP canaddition to giving external managers an help. As a result, you will be positioned to With our global reach, proven trackincentive to join a privately held business, gain access to a wider range of succession record, integrated suite of services and in-a high valuation can encourage highly planning options. From estate and tax depth knowledge of privately heldskilled family members to maintain family planning to transaction advisory and businesses, our practitioners truly act asownership, even if they have other wealth management, we can help you your trusted guides to help you navigateavailable career options. build an effective transition strategy. the succession planning process.