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Dream Big! Exit Your Business at Fair Market Value and Protect Your Employees

January 12, 2022 By Edward Lasak

ByEdward B. Lasak, CPA

Recently, business owners and their legal and financial advisors have expressed renewed interest for selling companies to their employees through an Employee Stock Ownership Plan (ESOP). Ongoing threats by Congress of significantly raising income tax rates and capital gains rates on businesses and business owners has rekindled this interest. Most experts now believe that future tax rates will be significantly higher than today. Therefore, cashing out now a percentage or the full value of your investment may be the best time to reduce risk, diversify investment portfolios, secure cash flow, and protect wealth. Furthermore, ESOPs offer special tax benefits to shareholders and ESOP companies that impact the decision-making, valuation, and due diligent processes on how to optimize the business value.

As a point of reference, selling a business to an ESOP trust is not new. ESOPs have been around for over 60 years, and there are now over 6,600 companies operating under this ownership structure. Also, it is important to note that many politicians view ESOPs as a retirement asset for working-class Americans, and consequently, ESOPs receive legislative support from both political parties, which given the existing pollical climate is quite remarkable.

Historically, ESOP companies have demonstrated a record of success. Overall, they can produce better than average financial results generating a stronger, more profitable company where employees prefer to work. On average, ESOP companies experience the following compelling benefits compared to non-ESOP companies:

Increased productivity: employees take ownership and act like owners. Furthermore, there is a 4% to 5% productivity improvement during the year an ESOP is adopted.
Two percent higher sales and employment.
Fifty percent fewer bankruptcies.
A more motivated workforce: Employees earn 5-12% more in wages and are less likely to lose their jobs.
Richer retirement plans by more than double.

So, what exactly is an ESOP and why is it so attractive as a plan to exit their business? As a brief definition, an ESOP is a tax-efficient leverage buyout where a company borrows money to purchase shares and contributes shares to a trust as an employee benefit to its employees. In essence, a trust owns the shares of a company’s stock that results in an employee benefit plan to its employees. From a legal perspective, it is classified as a defined contribution plan that is governed by ERISA and IRS regulations.

With this ownership structure, ESOPs offer several compelling benefits to business owners and their employees. Specifically, shareholders benefit as follows:

A business can be sold quickly at fair market value, in a confidential and efficient manner. Consequently, there is no need to list the business publicly for sale, thereby providing the opportunity for a quick sale without revealing confidential information with competitors and the public. The fair market value is determined by a business appraisal calculated at fair market value.
Perhaps even more compelling to many business owners is that there are impactful tax advantages resulting from ESOPs for optimizing valuations, cash flow, and wealth. Most notably, S-Corp ESOPs do not pay income tax on earnings resulting in significantly greater cash flow. Consequently, company loans are paid off with pretax profit which accelerates the payoff. Also, business owners may defer, or even avoid entirely, capital gains on the sale if the process and investments comply with Tax Code Section 1042 requirements.
It allows ownership the opportunity to reduce portfolio risk by cashing out a portion of their stock ownership. This provides shareholders the opportunity to diversify their assets in other investments rather than having most of their wealth tied up in one, high-risk business.
It saves jobs over the option of selling to strategic investors, and most importantly to many owners, preserves the family business legacy. Many business owners would prefer selling their businesses to their employees because they have been the people who have helped them grow the business and make it prosper. These employees can manage the business without day-to-day involvement by the business owner. In many ways, employees are the biggest portion of a company’s goodwill, and this sales option preserves that asset. It offers the perfect partnership of owners and their employees for selling a business.
It is a great employee retention vehicle which is especially important now during COVID. It is a common fact that employees prefer working for an ESOP because they have an ownership stake in the financial performance of a company. Likewise, ESOPs provide the added opportunity to offer stock options to reward key employees beyond the ownership benefit.
It allows business owners to sell their businesses at fair market value even when there are limited buyers available in the market.

Likewise, ESOPs offer several compelling benefits to its employees.

First and foremost, employee jobs are protected, and operations are not consolidated elsewhere.
Moreover, employees will share in the profits and value increases of the company. Company shares are held in ESOP Trust for the benefit of employees. As the company grows in value, it adds to employee retirement benefits. ESOP employees generally retire with richer retirement benefits compared to non-ESOP companies.
Employees feel and behave like owners, even though they may not directly run the company.
Studies show that employees prefer working at employee-owned companies.

On the other side of the coin, ESOPs are not for every business owner. Here are a few restrictions of ESOPs.

As a first requirement, the company must be large enough and growing to absorb the cost of increased governance. Moreover, the balance sheet needs to have limited debt to absorb increased debt capacity needed to fund the transfer and begin paying off existing shareholders. Usually, the deal is financed with 40% to 50% in bank loans, and the remainder of loans from shareholders.
Normally, ownership cannot cash out and leave. Most likely, ownership will be needed to stay on board to manage the company for next three to five years until bank loans are paid off.
Although employee and management are protected from strategic buyers, there may be fewer opportunities for optimizing the company, and capital expenditures may be tight until some of the debt is paid off.
Employees benefit long term from a successful company, but it may take several years until they build up a meaningful equity in the company.
Ownership can no longer operate the company without sufficient controls, increased fairness, and complete transparency.
Management will need to comply with increased regulation from ERISA.

Summary

For businesses that qualify, ESOPs provide an attractive exit option for selling a company at fair market value to its employees in a relatively quick and confidential manner. Moreover, the sales process can be done all at once or implemented over a time based on the preference of ownership. Likewise, it can be a process for cashing out a partner or to diversify ownership assets. It also assures ownership that their employees will be protected, and their family business legacy preserved.

Perhaps most importantly, tax advantages are profound. First, S-Corp ESOPs do not pay income tax. Second, with Tax Code Section 1042 compliance, capital gains tax can be deferred or even avoided entirely with this sales option. Likewise, this retirement option becomes even more attractive option as tax rates increase.

Although ESOPs result in new compliance cost, this increased compliance can result in a more professional management process with annual valuations, oversight by outside board members, the benefits of annual audits, and overall increased transparency.

Get started now with a free assessment of this exit option.

A Series on Value-Building Models

June 7, 2021 By Edward Lasak

By Ron Burgess and Edward B. Lasak, CPA

This article is the third of a series on how to increase business valuations and reduce risk by using value-building models that are available in the marketplace. My analysis comes from 35 years of experience as a CFO, COO, and Treasurer at Public and Private Companies and six years as family business consultant.

Series of Articles on Value-Building Models

This series describes value-building models that increase the appraised value of a company by increasing future cash flows, improving the sales multiple, and reducing operating risk. Moreover, it adds a CFO’s perspective of each model. Here is a summary of first three articles written:

Article One: Why Is Building Value So Important?

Article Two: The Valuation Wheel: Eight Strategic Business Drivers That Build Value and Reduce Risk.

Article Three: The Value Diamond Value Model

Introduction

In this article, we present Value Diamond Model. This model that was developed by Ron Burgess who has a 35-year career as a marketing professional, business owner, and consultant. Ron started marketing company called Red Fusion where he created and managed over 500 websites and marketing plans. From this experience, Ron has become a marketing expert. He is someone you will want to consult with about improving customer engagement, managing customer relationships, differentiating your business from competitors, growing revenue, and increasing operating gross profit margins.

If your goal is to optimize value for your shareholders, this article is a must read. Specifically, it provides a foundation for monetizing your position in the marketplace and increasing the stickiness of your customers making your company more indispensable to them. It gives you a process on how to improve customers stickiness and top-line revenue from a customer and market perspective.

The Value Diamond Model

The Value Diamond of customer perceived value is a model to help evaluate how customers compare a company’s product or services with its competitors. It was constructed as an easy and quick way to help clients improve and grow revenue. The concept is based on a marketing approach that customers ultimately shape company value based on their buying behaviors. Buying behaviors are driven based on perceived value.

Getting Started on a Strategic Plan

Small business owners are often “just too busy” to start and complete a comprehensive strategic plan. It is easy to criticize them for not taking the time, except it is often true that to keep the business going, owners need to work in the business and rarely have time to work on the business.

Conducting regular involved strategy sessions is seen as an exercise that can greatly increase the total value of a business. But time, knowledge of the process, and lack of other managers in a business can fall to the owner alone. While good planning can happen in this scenario, it often falls behind daily demands. It can also miss the valuable input from employees and a realistic look at competitors, external threats, and opportunities. Very small businesses also lack the cash to get outside help from professionals.

The Value Diamond can bridge that gap by providing an easy process with modest time commitments to start developing value-building strategies. It works as a first step and provides a periodic snapshot on areas that need improvement in your business. Furthermore, it starts with the most important component of your business and that is your customers. Generally, adding emphasis on planning tends to increase value. Likewise, structuring management to allow more executive time for this process will become a long-term benefit.

Perceived Value

A customer’s perceived value is constructed from four buying elements: 1) quality, 2) customer service, 3) the price, and 4) the perceived image (or branding) of the company. In the world of marketing, customer perception is more important than reality because only buying behavior affects revenue.

The use of other value-building models is desirable and necessary because operational issues drive margins and profits which in-turn drive profits and business valuations. The Valuation Wheel discussed in article 2 is a good model for looking at the financial and operational aspects of business valuations.

Use of the Value Diamond serves as a way to compare products and services between companies, so the examination yields a priority of what aspects of operations should achieve the greatest benefit.

Unlike the more structured approaches previously mentioned, the Value Diamond can be easily estimated by managers and salespeople who are aware of competitive forces. This simple approach is completed in just a few minutes while most evaluation methods require considerable discovery before making the evaluation.

This approach allows an initial quick shot of the customer’s perceived value, while encouraging more discovery and research to verify and deepen the analysis. Advanced approaches break down the four dimensions into component parts allowing greater accuracy and insight.

Examples include customer feedback loops to gain objective information. These methods include consistent periodic surveys, active competitor databases, product engineering improvement data, and customer service records of product and customer interaction.

The diamond is a spider chart with four dimensions, thus the “diamond”. Using a scale of 1-5 each of the dimensions (or characteristics) is scored.

Quality 1- is low, 5 is high
Service 1- is low, 5 is high
Image 1- is low, 5 is high
Price 5 is low, and 1 is high

Each characteristic is scored for the company and two (or three) competitors. They can be used in a simple chart like below or plotted on a spreadsheet using the format below and charted in a spider graph.

	Your Company	Competitor 1	Competitor 2	Competitor 3
Quality
Service
Image
Price

Scores between 1 and 5 are then entered into a spreadsheet and plotted using a spider chart.

Quality, service, and image are scored 5 is high, and 1 is low, while price is scored the opposite; 1 is high price and 5 is low price.

Note above: This image uses a scale from 0 to 100 because it is an advanced, calculated model based on outside feedback. When using the tool manually the 0-5 model seems to be less confusing, however the outcome is the same.

The gap between the subject company and competitors become the areas that need action. Note above that there is a substantial “gap” in service. Your company has a perceived advantage over the competitor in service delivered. When the quality is the same, and image is lower, the real service image could be better communicated which may allow a matched price as well.

Additionally, the relative gap differences can be easily evaluated to determine investments required compared to the relative value gained compared to competitors. This is a quick way to determine what issues need work first.

For example, if image and quality are lagging behind competitors, it may be that improving image is much less costly than completely re-engineering a product line. While both should be of concern, with a limited budget, image can be helped in a short time while new engineering or a continuous improvement process would take months or years. Therefore, the priority of tasks is easily determined compared to other strategic development models.

The Value Diamond is not intended to replace strategic planning but to jump start it or supplement it. It does not take into account many operational inefficiencies or HR and other administrative issues. Therefore, other models are more appropriate. However, the argument for a quick start rather a delayed start or an incomplete plan is a strong one. Adding this as a model to all strategic planning processes is also beneficial. We suggest that you continue your planning process using one of the systems described by this series of articles.

A CFO Perspective

Creating value of a business starts with its customers. Without them, there is no effective business model. Therefore, any serious value-building model should start by analyzing the perceived value of its customers, thereby knowing what differentiates your company from its competitors. This is where The Value Diamond excels and adds value. The Value Diamond Model measures the perceived value of its customer by analyzing four buying factors: quality, customer service, image, and price.

This is a productive model for starting the value-adding process or adding it to the model that you are using. From a CFO’s perspective, I endorse this model because it adds balance to the value building process by emphasizing what makes you different to your customers. Many times, value-adding models place too much emphasis on expense cutting initiatives because many times that is the easier action to take. This model forces you to focus time and effort on probably the most important value driver and that it the relationship with its customers.

Conclusion

What makes the Value Diamond Model especially noteworthy is that it measures the perceived value of customers. The higher the perceived value of customers, the stickier customers are, and this stickiness leads to reduced customer turnover and increased revenue spending. It is a powerful tool for analyzing the quality of revenue, and likewise, can be used to create future value.

The Value Diamond Model provides a simple methodology for measuring your customers perceived value of your company from anecdotal feedback from sales and marketing personnel or more objective data from your marketing system. Moreover, it allows you to compare your company with its competitors, thereby helping you understand your competitive advantage and opportunities for improvement. Due to its simplicity, it can be the first step of beginning a strategic planning process, or it can add significant value to your exiting value building model that may be deficient of the customer analysis with your company.

In summary, it is a value-building model that you should adopt no matter what other overriding model you have selected for adding shareholder value. It focuses on the concept that customers ultimately shape company value by the buying decision they make daily.

Likewise, this model can measure the perceived value of competitors, and thereby can provide insights on how you can differentiate your company against them. We have all heard how important the market and customers are for driving revenue, but how many of us have taken the time to measure comparisons with competitors. This model provides a simple methodology to make these observations.

For more detailed information on the Burgess Value Diamond: The Mystery of Why People Buy: It’s The Perceived Value – RedFusion Media

About the Authors:

Ron Burgess

Ron Burgess is a serial entrepreneur who has started six businesses; all achieving market success. He started his consulting career following his tenure as the Director of Management Services for a national consulting firm in the 1980’s. There he developed business analysis products used by many hundreds of businesses. He has been a full-time consultant to small business since 1989, and is a recognized expert in the field. In retirement, he is on several company and non-profit boards, and founded a non-profit, MicroGiants Mentoring to record and transfer his knowledge, tools and experience to young individuals who want to start businesses. Connect on Ron Burgess | LinkedIn or MicroGiants.biz

Edward B. Lasak

Ed is a business strategist who has 35 years of experience working as a CFO, COO, and Treasurer at publicly and privately owned companies as well as local government. From his unique experience, he is skilled at using financial numbers and valuation methodology as operational metrics in managing operations and distribution for greater performance. He also successfully leverages IT solutions and new technology for improved operations. Ed is a CPA and has a Bachelor and Master of Science Degrees from Illinois State University. He is certified as a COSO Internal Control expert by the American Institute of Certified Public Accountants.

The Valuation Wheel

April 29, 2021 By Edward Lasak

By Edward B. Lasak, CPA

Value-Building Series: Article Two

The Valuation Wheel

This article is the second of a series of articles on how to increase business valuations and reduce operating risk by using available value-building models that are available in the marketplace. This analysis comes from 35 years of experience as a CFO, COO, and Treasurer at Public and Private Companies and six years as family business consultant.

Value Building Is a Good Investment. $1 Invested Returns $820 to the US Economy (www.NIST.com).

Introduction

Experienced CFOs are trained to work as an integral leader with operating teams and ownerships to develop and implement strategies that increases shareholder value as well as to reduce operating risk. The value process begins with a comprehensive strategic plan of value-added strategies that are developed from a SWAT (Strengths, Weaknesses, Opportunities, and Threats) analysis, succession planning, and financial statement forecasts for the next three-to-five years. This process provides a roadmap of where the Company is going and how it is going to get there. Company valuations are performed annually to confirm increased shareholder value. Fortunately for business owners and consultants, there are several models available that will assist you in creating shareholder value and reducing operating risk, and therefore, there is no compelling need to reinvent the wheel.

In this article, I will discuss the Valuation Wheel that I created after 35 of experience of managing companies. The Valuation Wheel starts with customer relationships and focuses on key value drivers available for creating value and reducing operating risk. It provides a comprehensive framework of business concepts and best practices arranged by components of the financial statements to identify and analyze value drivers that should be addressed in your strategic plan. Finally, it requires an on-going process where operators and ownerships are focused on optimizing value. It allows one complete flexibility in creating and implementing a strategic plan with no upfront investment, ongoing fees, or specialized rituals and acronyms. To optimize value, this process requires the onsite assistance of an experienced CFO and marketing expert. Hands on experience operating in the seat of responsibility matters most in creating value.

The Valuation Wheel

Good Stewards Are Expected to Build Value.

The Valuation Wheel was developed to build value in companies by incorporating robust value-added strategies into the strategic plan, and then use the plan as a roadmap to evaluate management in achieving these results (see Exhibit 1). As you will readily see, the value-building drivers cover all potential ways of increasing value with a holistic perspective based on valuation methodology and centered around the financial statements which are the key financial parameter of defining success. Some value-building models focus more on the process, whereas the Valuation Wheel focuses more on how to create value. Moreover, successful strategic plans must have both robust value-added strategies as well as an ongoing, rigorous implementation process of leadership, alignment, and accountability to optimize results.

The value-building process starts with a valuation of a company’s “as is” and then develops a strategic plan that can add incredible shareholder value and reduce operating risk. A SWAT analysis along with an integration of value-building strategies from the Valuation Wheel are used by ownership and the management team for developing a comprehensive strategic plan. Financial statements are forecasted out for the next three-to-five years to provide the roadmap of value for evaluating progress, ensuring alignment, and establishing accountability. Internal company valuations are performed annually to confirm the increased shareholder value and reduced risk, and management is rewarded accordingly.

Likewise, the Valuation Wheel is designed to find and optimize value establishing a foundation for upcoming transitions in ownership including sales to third parties, planned family transitions, and ESOPs. Furthermore, all good management teams worth their salt need to grow and add value to the enterprise, otherwise an owner’s best option may be to sell the company and redeploy the capital to other endeavors.

Specifically, the Valuation Wheel is a circular, ongoing system of eight powerful value-building drivers that encourage continuous improvement and build shareholder value with a holistic perspective based on valuation methodology. The first three drivers focus on revenue, the engine of any successful business, and it is broken down by markets, customers, revenue, and gross profit margins. The fourth driver focuses on an efficient process for producing and delivery product and services. It leverages assets such as the workforce, customer service, equipment, and technology to consistently deliver high-quality products and services to its customers. The fifth driver focusses on reinvesting capital back into the business that makes the company more effective at fulfilling its mission and earns high rates-of-return (ROIs) on the capital reinvested in the business.

The sixth driver focuses on optimizing the balance sheet, borrowing capacity, intangible assets, and cash flow. This is the driver where one builds in a sound risk management program to protect assets and future cash flows of the company. The seventh driver looks outside of the company for value opportunities including M&A and working partnerships. This is a growth opportunity often missed by the operating team. Knowledge about competitors and outside opportunities is of utmost importance and can significantly add value to the company and provide a pool of potential buyers when selling. The eighth driver focuses on a monthly and quarterly management review process that evaluates just of how well the management team is doing in meeting the benchmarks, milestones, and financial projections of strategic plan. Succession planning is a key activity of this driver.

The following provides further amplification of each driver, and how the eight driver strategies work together in building value and reducing operating risk.

Investigate Market Potential:

There is nothing more important to a success of a company than analyzing the market and assessing Company’s position in it. Being number one or two in a market provides strategic advantages to a company for influencing pricing and growing market share without the fear of losing customers. Moreover, this position in the marketplace could justify a higher sales multiple from other companies in that industry. Therefore, understanding your position in the marketplace and your options for improving that position is one of the most important steps for creating value.

In analyzing market potential opportunities, we ask questions like this. Can you become number one or two in your marketplace and what is the required investment to achieve that status? Are there opportunities or cracks in the market to provide new goods and services where you could increase market share and gross profit margins? Can you expand products or services with existing customers to increase revenue, margin, and customer engagement? Is there an opportunity to expand geographically and leverage your fixed cost to support more revenue? Do you know and understand your competitors and how they would react to changes that you are contemplating? Is there an opportunity for offering lower pricing, improving distribution, providing superior quality, and improving customer service to grow revenue and profits?

Improve Customer Loyalty and Stickiness:

Equally important to market potential is your customers perceived value of your company. The stickiness of your customers defines just how valuable your company is to them. The stickier they are to your company, the less the chances that they will leave you. This stickiness can have a profound impact on your company’s valuation. As with market position, this is another driver that justifies a greater sales multiple over other companies in your industry or market. Every business starts and ends with the perceived value of its customers. Performance factors such as quality, customer service, a superior customer experience, digital convergence, and company image can make your company indispensable with its customers without relying on being the low-cost leader.

With this value driver, we ask questions like this. Why do your customers do business with your company over your competitors? Can you increase billing rates or reduce working capital requirements without losing business? What is your competitive advantage and how can you further leverage it in satisfying the needs of customers? How can you increase customer engagement and improve the customer experience? Are you communicating with your customers quarterly and asking them how well you are doing? Do you have an effective marketing plan in place to track customer satisfaction and securing new customers? Do your customers value the goods and services that you provide to them and do you have surveys in place to support their satisfaction? Can you structure revenue into a recurring revenue, a subscription model, contracts, and/or legally protected trademarks and patents resulting in higher retention rates?

Articulate Your Story: Gross Revenue and Gross Profit Margins:

It is a known fact that buyers will pay a higher sales multiple for a positive revenue story, especially where revenue streams and gross profit margins are increasing. Of equal importance, one needs to have a robust digital strategy and marketing plan for growing revenue on the web. Generally, higher sales multiples will translate into increased business valuations. Moreover, the quality of past operating performance and trends makes the accuracy of your forecast more predictable and believable. Likewise, it is extremely important to be developing and investing in new sources of revenue so that future revenue streams will continue to grow, thereby demonstrating sustainable revenue growth.

Here we ask questions like this. Are your revenue and margins improving? How does your revenue growth compare to industry standards? Is your revenue concentrated in a few customers? Can you analyze customer retention and profitability through contribution margins? Is there an opportunity to add resources to your sales function to further grow revenue? Can you add profitable revenue further leveraging existing fixed cost? What stage are you at in the product development cycle?

Increase Efficiencies, Scalability, Productivity, & Quality:

This value driver addresses the effectiveness and efficiency of consistently producing and delivering high-quality goods and services to customers. Value from this driver is derived from employing a motivated workforce that operate in concert with the values of the company and performing jobs that they are properly trained to do. The workforce is supported by a high performing culture where the workforce works together as a team in achieving strategic objectives with full alignment and accountability for results. Everyone employed has performance metrics to achieve and there is nowhere to hide for non-performance. It considers the quality of goods and services consistently provided and the superiority of customer service.

Here we ask questions like: Is there an opportunity to further reduce cost? Can you scale your business to reduce fixed costs as a percentage of revenue? Do you track and measure productivity and quality? Is there alignment with goals and full accountability of performance? Do you have effective training programs in place? Can you increase productivity and quality with improved processes and tools? Do you have a strategy for digital convergence? Do you have the right people on board that embrace the values of the company and are they in the right positions? Are you migrating the owner out of the day-to-day operations?

Invest in High-ROI Projects:

This value driver focuses on reinvesting capital back into the company to create value with increased revenue, improved margins, superior product or service offerings, and profitable expansion into new markets with new and existing products and services. A focused capital plan that prioritizes investment opportunities prioritized by return-on-investment (ROI) is a key building block for adding shareholder value.

Here we ask questions like: Are new projects evaluated and prioritized based on its ROI? Are you building superior solutions, products, and services for your customers? Are you missing out on profit improvement opportunities by not reinvesting in the company? Do you understand your cost of capital? Have you prepared a capital plan that supports your strategic plan?

Capital planning is a key component of this value driver. Capital projects should be vetted, evaluated, and prioritized based on the following criteria:

Is a capital investment necessary to meet regulatory requirements? This is considered a cost of staying in business.
Does the capital investment produce a superior ROI? Likewise, high return projects should be implemented ASAP.
Does the capital investment provide redundancy and backup to key processes that support your business continuity plan? Customers expect that their orders will be fulfilled even during emergencies and natural disasters.
Does the capital investment improve product or service quality, customer service, or the customer experience?
Are you investing in new technology and digital convergence?

Optimize Balance Sheet and Cash Flow:

This value driver focuses on ways to increase cash flow, improve borrowing capacity, mitigate operating risk, reduce working capital, and implement strong corporate governance. The goal with this value driver is to fully optimize every asset on the balance sheet including goodwill and debt to equity. It addresses the availability of short-term and long-term financing sources by optimizing lines-of-credit, payment terms, collection practices, and borrowing capacity. It stives to optimize performance by striking the optimal balance between long-term debt and equity. Finally, it minimizes the risk of personal guarantees and rewards effective corporate governance.

Here are some of the questions addressed with this value driver. Do you analyze opportunities to free up the use of working capital allowing you to minimize the use of lines-of-credit? Is there an opportunity to recognize revenue quickly under Generally Accepted Accounting Practices (GAAP)? Do you require customer deposits for projects requiring long projected lead times? Are you able to turnover inventories more frequently? Do you have tax strategies in place to reduce taxes? Do you review key ratios such as liquidity and profitability ratios to see if you are improving? Are you optimizing borrowing capacity, renegotiating banking relationship, and improving bank covenants? Are you exploring equity opportunities for new sources of capital and expertise? Do you own surplus assets or underperforming assets? Are you protecting your going concern with annually updated Buy/Sell Agreements?

Investigate M&A Opportunities and Mutually Benefiting Partnerships:

This value driver focuses on opportunities that are available outside of the company. This value builder identifies opportunities with business associates and competitors through teamwork, combined operations, or strategic partnerships. Leadership focusing solely internally will miss out on substantial potential benefits of combining operations. These opportunities may seem awkward at times, but if both companies benefit financially, why not pursue a partnership or merger. Likewise, M&A opportunities should be investigated and analyzed to see if there is strategic value. Finally, is there an opportunity to insource or outsource segments of the operation to reduce fixed costs?

Here we ask question like this. Do you know your competitors, and do you benchmark operations with them? Do you have a relationship with owners of competing companies? Do you develop productive business relationships through industry groups? Do you know businesses that produce and offer similar products or services? Do you consider combing operations with other companies to possibly leverage assets and improve margins? Do you research other companies in your marketplace to understand how you are different or similar? Do you look for partnership opportunities with other companies that can add value to your business and would better serve the customer? Do you investigate like-kind companies for that are for sale?

Forecast and Reevaluate Performance Quarterly:

This driver reviews and evaluates performance to the milestones, action plans, and the financial statement projections identified in the strategic plan. It is a time to evaluate the performance of the management team for alignment and accountability focusing on what is working and what needs improvement. As part of this process, full financial statement projections should be updated based upon revised assumptions and performance factors. Finally, succession plans should be evaluated, and deficiencies corrected quarterly as part of the review process.

Here we ask questions these kinds of questions. Are financial statements reviewed monthly or quarterly with operating team and ownership? Do you analyze actual results comparing them to forecasts, budget, and last year and understanding performance variances? Are you on target to achieve financial statement milestones of the strategic plan? Do you update financial forecasts monthly looking three-to-five years out consistent with strategic plan? Do you review progress and accountability for achieving action plans? Do you update the business valuation annually based on the latest forecast? Do you review and update succession plans? Is the employment of key employees secured? Are you migrating the owner out of the day-to-day operation? Do we need special skills and new talent to grow the company?

Transitions and Business Exits

Transitions to next generation ownership can be planned over time as part of this process. Transition planning is ongoing and requires a three-to-five-year process to ensure success. It is not a one-time event prepared in 90 days or so like some may believe. The goal is to increase shareholder value and reduce operating risk so that the owners have more transition options, greater flexibility, and increased value when it is time to transition out of the business.

Transitions are personal decisions, and the right option depends upon the desires of owners and what it best for them and their families. In general, many owners are reluctant to plan directly for transitions for many reasons, so increasing value is one way of moving forward on the tough topic. Some service providers are looking for the opportunity to sell these businesses to outside parties, but the most common practice in real life, is to transition these businesses to a new CEO within the family. Besides building value, internal communication between family members and stakeholders is of utmost importance.

Conclusion

Management teams, owners, and Boards of Directors should implement a value-building model that is in complete alignment and with full accountability with its company’s strategic plan. It is the responsibility of a good steward to do so.

The Valuation Wheel is a value-building model that can be used to build value and reduce operating risk. It is a comprehensive model that intensely focuses on eight value-building strategies that can be used along with the SWAT analysis for developing a robust strategic plan. It then incorporates forecasts of the financial statements as the overall scorecard and adopts monthly or quarterly meetings to keep management on track, accountable, and in alignment with strategic the plan. It is best implemented for optimal value with the services of an experienced CFO and marketing consultant.

The author is completely agnostic as to what value building model is used. One may be best served by understanding the strengths and shortcomings of each model, and then designing a specialized model for your company. This adaptability can produce exceptional results but may take greater skills and more experience to implement and adjust based on performance. No matter what model you select, it is important to get started as soon as possible and apply it rigorously to realize optimal results.

Once a value building model is selected, it is critical to conduct monthly or quarterly assessments with your management team defining the value created and adjusting your road map moving forward. Also, an annual valuation should be conducted to confirm shareholder value secured. Outside assistance will help keep the process moving and results achieved as planned.

About the Author

Edward B. Lasak

Introduction

April 22, 2021 By Edward Lasak

By Edward B. Lasak, CPA
Value-Building Series: Article One

This article is the first of a series of articles on how to increase business valuations and reduce risk by using available value-building models that are available in the marketplace. My analysis comes from 35 years of experience as a CFO, COO, and Treasurer at Public and Private Companies and six years as family business consultant.

Introduction: Series of Articles on Value-Building Models
The purpose of this series of articles on value-building models and best practices is to provide business owners and service providers with an overview of the various approaches available in the marketplace for increasing shareholder value and reducing operating risk.

With this article, we are setting the stage. We will discuss the importance of increasing shareholder value, the benefits for doing so, the role of the CFO, and the general approach for capturing value. Future articles of this series will discuss the various models and approaches available in the marketplace.
Specifically, the next article will focus a very popular model, the Entrepreneurial Operating System. It is a highly regarded model and supporting infrastructure with professional implementors that is discussed in the book called Traction, written by Gino Wickman. In future articles, we will explore other models such as Baldrige, Value Builders, and the internally developed Value-Building Wheel.

Fortunately for business owners, there are several excellent value-building models available with trained professional implementors that will assist owners in optimizing shareholder value. Although I am completely agnostic on what model to use, I highly recommend that business owners adopt the one that best suits its company’s culture and begin rigorously implementing it with the support of outside professionals.

Why Is Building Value So Important?
There is nothing more important to the long-term success of a company than increasing its business valuation and reducing its operating risk. These are the two valuation methodologies used by busines appraisers in determining the valuation of a company. Lower risk and higher profits and margins lead to higher valuations, often with higher sales multiples exceeding industry averages.

Well run companies have a strategic vision, value added strategies, best practice processes, and high-performance cultures to increase value and reduce risk. These same companies use the latest best practices to reduce operating risk and protect value. These companies make significant high-ROI investments, provide religious-like implementation focus, and manage accountability down to each employee to continuously improve customer satisfaction and develop new and improved ways of meeting their customer’s needs with the highest quality and in the most efficient manner. These companies use value-building models supported by dashboards of meaningful metrics and forecasts of the financial statements to evaluate and reward its management for increasing shareholder value rather than just performing caretaker responsibilities. This process becomes ingrained in their cultures resulting in high performance management with full alignment with employees, customers, and service providers.

Likewise, this same value-building process and risk management should be adopted for family-owned businesses. Many times, the family business is the largest asset on owners’ personal balance sheets, and it is in their best interest to optimize this asset for upcoming transitions and retirement, even if owners remain actively involved in the business to the very end. It is a basic fact that owners will have more favorable and flexible transition options available to them when their business is optimized and growing with minimized operating risks. Marginal businesses are unattractive to others, and consequently, are very difficult to sell, especially if owners are no longer able to run the business. In fact, some business professionals agree that one should either increase the value of a business or sell it to someone who will.
Many family businesses are owned and operated by Baby Boomers who were born in the years of 1946-1964. These owners are now in their 60’s or 70’s approaching some sort of voluntary or involuntary transition sooner rather than later. This is yet another reason why this is the right time for them to begin creating value that will increase their options and value no matter what ultimate exit strategy is chosen. In essence, value building brings exit planning into the present without forcing the owner to decide on the ultimate exit option now.

How Does One Build Value?
Incremental value will not magically happen without a plan and concerted effort to do so. Simply put, value is realized through a process that starts with a well-engineered roadmap supported by a viable strategic plan with real vision and incredible value strategies to improve the customer experience and stickiness. The strategic plan is where one analyzes the various value drivers to identify meaningful strategies for increasing shareholder value.
The overall objective is to improve customer satisfaction and find new and improved ways of becoming more indispensable and valuable to customers, always with the highest quality and the most efficient process. The roadmap shows where the company is going, describes how it will get there, and provides insights on what to do once it gets there. It is embedded with financial projections of the financial statements and meaningful, quantifiable metrics so that progress can be measured, and accountability can be evaluated in meeting aligned responsibilities.

Once the plan is in place, the process relies on a high-performance culture that optimizes every asset on the balance sheet along with its goodwill and its workforce to fully engage implementation. Likewise, to keep the process on target, it is normally supported by effective IT systems and infrastructure, an effective performance management process, a comprehensive marketing plan, and COSO endorsed systems of internal control. As the final component, full alignment is essential to ensure that everyone is on the same page and singing the same tune day-in and day-out without exception. Full alignment requires having the right people in the right jobs which is a cornerstone of building the perfect company with the highest potential.

Regarding the cost/benefit of such a program, it is a no brainer to move forward quickly. According to Baldrige: Department of Commerce (www.NIST.com), for every dollar invested in this process, it will create 820 more dollars in return for the US economy. There are several highly structured models available to facilitate the value-building process. Furthermore, there are professionally trained CFOs and consultants available to implement this process as needed without incurring the high cost of full-time employment.

What Value Does A CFO Provide?
As one option, most value-building models have professionally trained implementors that are highly educated and trained on implementing that methodology. These professional implementors can be engaged by companies as outside consultants to provide ongoing guidance to keep management focused and the process on target.
Another option is to engage an experienced CFOs, fully armed with significant business experience, advanced business degrees, and CPA certifications, to quarterback the value-building process and to reduce operating risk. CFOs are experienced in leading the development of meaningful strategic plans equipped with value-building strategies that optimize shareholder value. They then lead the implementation process by providing unbiased leadership and key metrics and financial forecasts for measuring results. CFOs are the official keeper of the books and performance metrics that are commonly used to measure progress and evaluate performance.

More importantly, CFOs are impactful change catalysts to all departments for keeping the process on track with full alignment and engagement. They are respected as a neutral party from operating departments and are in the leadership position that can cross department lines for implementation, alignment, and accountability. They can use their sphere-of-influence, analytical skills, and business experience in supporting operating teams and ownership.
Moreover, CFOs provide other important related services. They normally act as the professional interface with valuable outside service providers such as banks, CPAs, attorneys, insurance companies, and benefit providers. Service providers can provide incredible value to the value-building process when their efforts are collaborative and with clearly defined roles and deliverables as coordinated by the CFO. CFOs are accustomed to leading risk management functions that reduces operating risk and protects assets.

Finally, CFOs are trained on valuation methodologies and can prepare business valuations of companies using three standard valuation approaches: the income approach, the market approach, and the cost approach. Performing annual valuations should be a key component of any effective value-building model. By understanding these valuations, management will better understand the impact of the various financial drivers and how they can be used to increase valuation of the company, especially by increasing the sales multiples exceeding other companies in that industry.

Conclusion
Every family business should adopt and begin using a value-building model and deploy a risk management process to increase shareholder value. The potential benefit and financial return to your company and your personal balance sheet can be overwhelming. According to Baldrige, Department of Commerce website, benefits for the US economy to its implementation cost is estimated at 820 to 1.

In addition to optimizing the value of your personal balance sheet, this value-building and risk management process will begin preparing owners for its company’s next transition and provide more security during retirement. Many family-owned businesses are owned and operated by Baby Boomers who are now in their 60’s and 70’s years of age. This means that these businesses will be transitioning sometime soon.

Please note that transitioning the business does not mean selling the business now. Instead, it means preparing to transfer the business to the next person whomever that might be with a process that starts now. Why wait? Consequently, all profitable and growing businesses will be transitioned with or without its owner say so. Likewise, poorly performing businesses that are unattractive to others may not survive. Owners and their families will have more robust exit options available to them, the more the business is optimized with reduced operating risk.

Thankfully, there are several robust value-building models available in the marketplace to choose from. Just as important, professionally trained CFOs or outside consultants should be engaged to help lead this process and coach management to stretch for increased value and continuous improvement and keep the process on track. CFOs can also help to reduce operating risk.

About the Author
Edward B. Lasak
Ed is a business strategist and consultant who has 35 years of experience working as a CFO, COO, and Treasurer at publicly and privately owned companies as well as local government. From his unique experience, he is skilled at using financial numbers as operational metrics in managing operations and distribution. He also has successfully leveraged IT solutions for improved operations. Ed is a CPA who has a Master of Science and Bachelor of Science Degrees from Illinois State University. He is specialized in COSO Internal Controls from the American Institute of Certified Public Accountants.