“Your key people are all going to retire when you sell the business? Who the heck is going to know how to run the business?????” This is not a conversation that you want to be having as a buyer or seller.
If you are trying to buy or sell a business, you know that the key people who make the business run can be an important part of the value of the business. For most small businesses the value of the company goes home every night and you hope it comes back the next morning. Of course, now the employees may just work from home and not come in but the concept is the same — employees are a huge part of a business intangible value. As a seller, your business has more value if your quality staff is staying after you leave. Your business cannot function without knowledgeable management and trained competent staff that are reliable. Here are 4 ways key people fit into business valuation.
Employees are part of the valuation.
Businesses are people applying processes to make profits. Looking at the basic market method business valuation equation, Cash Flow x Risk = Value, employees impact BOTH sides of the equation. On the one side, employees drive the processes that create cash flow. On the other, the risk of loss of the institutional knowledge that is in your employees heads is a huge factor in the risk component of value.
Employees create value.
Few small businesses make money based on their hard or fixed assets. Yes, you need those assets, but ask most clients why they use a certain business and you will hear, “We use this business because they provide great service.” Great service comes from good people. The price may count, but quality includes the quality of the service your people provide.
Employees are related to growth.
In addition to quality management, more focus is currently being given to mechanics and trained technical staff. The ability to find and keep new trained or even trainable personnel is one of the biggest growth limitations.
People are your value.
While many owners can’t imagine it, the business is not the owner. In fact, in order to have value a business must be able to operate without the owner. Therefore you must keep your people. In a recent post, I explored how you can create value through your employees (which is something you need to do long before you begin selling your business).
When we evaluate businesses, especially for tax and gift purposes, employees represent the single most important factor when calculating a business’s intangible value. This is value that you want to keep for yourself as your business grows or a value you want to include for future partners in or owners of the business.
Contact me today to learn more about business valuation and what your company is worth.
By Greg Caruso, JD, CPA, CVA, The Art of Business Valuation, Harvest Business, LCC.
Employees are all over the news for demanding flexibility and better employment terms. For many businesses, employees are both the largest cost and the source of most of the intangible business value. Here is a primer on how employees and your business’s intangible value are related.
What is intangible value?
First, let’s start with the basics. Intangible value is all of the value of your business that is not represented by identifiable tangible assets. A business’s intangible assets are things such as money, furniture, computers, equipment, or real estate. Namely, anything we cannot see or touch.
What really creates intangible value?
When we talk about value (tangible or intangible), we are talking about the future profitability of a company. In reality, this future profitability is always about people, or employees who maintain and grow a company or business. You may say, “But Greg, Microsoft can just sell more copies of their software and make profits with very few people.” This is true in the short term. However, in a few years, no one would buy Microsoft products because they would already own it.
Companies need to keep updating and improving what they offer. Then, they need to sell, manage, and lead the product lines or offerings. Otherwise, the overall company or the value of the company would quickly fall as customers move to newer or easier-to-use products. (Remember the decline of the Blackberry for the iPhone?). All companies need “forever and continuous improvement,” or they will get left behind.
You employees create all of your intangible value over time. This is an especially important point for small business owners to remember.
How can you increase your intangible business value through your employees?
In today’s tight labor market, employees (and good employees) are especially important. But really, they are always important for your business’s value. There are simple ways to increase your business’s intangible value through your employees.
Hire the best. Train them, grow them, and keep them. This is hard work and if you are really successful you will lose the occasional well trained person but really, what is the alternative?
Compensate them well. I say compensate rather than pay, because benefits like flexibility, titles, and non-monetary compensation (i.e. retirement plans or health insurance) are often just as important as salary. Just remember, your competitors are lurking for your stars and they will pay more – at least on the hire date.
Create benefits that lock employees in. For instance, if your company gives large bonuses, pay the bonus over 3 years in thirds. If an employee chooses to leave, they are also leaving a big bonus behind. However, remember that if you need to lay them off, you will have to pay them the full bonus. Another option is to create a stay agreement, where the employee receives a bonus if they stay for 2 years under new ownership. Remember, ownership can change for voluntary or involuntary reasons.
Remember the huge cost of new hires. Although you are hiring the best, they will still need time to adjust to your company. By the time they are found, trained, and really up to speed, they are even more valuable. Don’t be chintzy with your best people.
Hire slow and fire fast. This might be the most important advice for any business owner. Back to point one–hire the best, even if it takes time. Then, don’t be afraid to let people go. How many times has a hire that did not feel like a fit at the end of the first week actually make it on the team? Yet I bet you put tons of time “trying” to get it to work. Let those people go after two weeks, not six months.
Contractually protect yourself. In most jurisdictions, properly prepared non-competes or non-solicits can be used to protect your firm from the loss of clients that might leave with a key employee. In my mind, these employees should be able to work in the field but not leave with your clients. The specifics of these provisions vary by state, so make sure to ask your lawyer.
Creating value for your company through employees means using both the carrot and the stick. Take your time to hire great employees. Then, keep them growing by compensating them well and keep them around by structuring benefits and contracts that keep them around and protect you. And don’t be afraid of letting employees go if they aren’t great, no matter how hard it is. Employees are the single most important part of a business’s intangible value, a value that you want to keep for yourself or for future partners in or owners of the business.
Asset Approaches in business valuation compares the value of the assets less the value of the liabilities (debts) of the company and the difference is the company value. The formula is Assets – Liabilities = Value.
For small businesses this tends to be limited to the physical tangible assets. Intangible assets such as the value of the customer list, value of systems and processes, etc. tend to be lumped into goodwill and are not independently valued under the asset approach.
The assets and liabilities are often valued to different standards of value. An easy way to think of standard of value is it answers “who is establishing this value”. Another way to look at it is “who is the buyer and who is the seller.” Also, in the case of asset methods, standard of value may include time available to sell on the market.
Book Value is the value the asset are carried in the accounting records. This is the purchase price less depreciation. This may or may not reflect a market value. This is a value to the seller for accounting and/or tax purposes.
Market Value tends to value assets at the current value, near what might be considered dealer or distributor prices. Namely what the company would have to spend to acquire assets in similar condition or what they might sell a few assets for under normal operations.
Liquidation Value is the sale price for the assets under assumptions about the timing of the sale. Orderly liquidation means perhaps 90 days to sell (a bad situation but not dire). Forced liquidation means auction value.
Clearly each of these assumptions will change the value found dramatically.
Below is a simple example without estimating a value for intangible assets or goodwill:
Note the range of values found under the asset method depending on the standard of value applied. Choosing which value is most appropriate will depend on the underlying fact pattern of the subject company.
If you own a business, or prepare business valuations, or advise business owners based on business valuations (i.e. attorneys, CPA’s, financial planners, lenders, business brokers, etc.) you owe yourself and your clients the peace of mind of really understanding small business valuation.
“The Art of Business Valuation, Accurately Valuing a Small Business”, written by Greg Caruso will be published by Wiley in Fall 2020. The book is geared for valuating businesses with revenues under $10 million. This resource is easy to understand yet addresses the technical side of valuing small and very small businesses. In addition, the related website has sample reports, checklists and working Excel files of many calculations.
