Last month, when we discussed the concept of intellectual capital we asked the question: “What makes a business valuable to potential buyers?” This is the most important question for most business owners who are considering transitioning their companies. Their business is a very large financial asset. For many owners, it’s their biggest and most important asset. To be able to move on to another phase of their lives, they will need to be able to sell it. And to sell it, they need to objectively determine its value and, if possible, increase that value until the right time comes for them to sell the company. Owner dependence is a key element of business valuation. If a company is too owner dependent, buyers will shy away. They will know instinctively that the business will not survive a transition in leadership, let alone thrive after the sale.
What Is Owner Dependence?
Owner dependence is a business’s reliance on the owner for the functioning of day-to-day operations. It means that the owner is too essential to the success of the company. Without him it can’t function nearly as well if at all. Some businesses can’t be transitioned because the talents of the original owners are too unique. Could the Rolling Stones survive without Mick Jagger? Fortunately, most owners are not that indispensable.
Typically the owners of owner-dependent businesses will:
- Be very involved in day-to-day operations
- Do most of the hiring and firing of employees
- Delegate little of the company’s management to others
- Be the primary customer or client contact person
- Make most of the decisions and do the strategic planning by themselves
- Share the company’s financials only with their accountants and the IRS
- Handle the company’s bills, payroll, and accounting
- Be personally liable for the company’s debts
Obviously this will have enormous impact on the valuation of a company. After a sale many business owners will help the new owner transition by continuing on with the company for a predetermined amount of time or until certain goals can be achieved. This works well if the company has knowledge or information repositories, databases, structures, and processes in place that will help the staff make decisions, train new employees, find and assist clients, and continue in their mission. In successful business transitions, the original owner finds ways to transfer his intellectual capital to the new owner or new management, and the company strengthens itself and becomes independent over time.
It’s much better for the company and for the owner if that independence happens before he puts the company up for sale, though. The better the company operates without the owner, the more desirable it will be to buyers. Ideally, buyers want businesses that run smoothly without input from the original owner or from them.
How Can You Tell If Your Business Is Too Dependent on You?
Take an extended vacation. This will reveal both the inherent strengths and weaknesses of your business. If you cannot afford to take a vacation, your business is certainly too dependent on you to sell. If that is the case, then the first step you must take is to strengthen whatever aspects of your business fall apart without you. That might mean hiring people. It might mean organizing your business differently or setting up structures of organization that help your employees know how to proceed when there is a problem. It might mean utilizing technology better so that some tasks can be done without an owner on site or without input at all.
These are the kinds of assessments that we at Prometis Partners help our clients make. Achieving these sorts of goals takes time – both to assess and to fix. Does your company have quality, dependable people in key positions? If the answer is no, it may take months or even years to find the talent you need. Perhaps the problem is with delegating. Sometimes owners who have built their companies up from the ground have a hard time letting go of control of it. This is another kind of challenge.
Most business owners are insufficiently prepared for a transition or a sale. According to a 2017 survey on owner dependency, the average business owner scored a 54% in preparedness. They are not ready. Millions of Baby Boomers with businesses are not ready, even as they approach retirement age. This process can and does take years, although we work with clients in various stages of preparation and on different timelines. If your goal is to decrease owner dependence and make your company more valuable, now is the time to begin this process – not 5 years from now.
If you would like to discuss how dependent your company is on your direct involvement and how that affects its valuation, we encourage you to take our ExitMap Assessment. This questionnaire takes just 15 minutes to complete, consists of only 22 questions, and produces a full color 12-page summary report that will be emailed to you and Prometis Partners. For more information or to answer any questions you may have, contact Vincent at (616) 622-3070 or by email at firstname.lastname@example.org for your initial consultation.