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.
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.