Larry Lane
VR President

One corporate accountant at a company colorfully described employees as “costs walking on  legs.”

Though businesses want maximum efficiency from their employees for minimal cost, the actual measures of intangibles such as corporate efficiency due to employees’ capability or customers’ loyalty due to employees’ efforts are frequently overlooked as gray aspects in a black and white monitoring process.  Each employees’ contribution is individually unique and different depending upon the given environment.  Most of all, they cannot easily be valued according to traditional financial principles.

However, if you view employee knowledge as an “asset”, you will arrive ultimately at the role that your employees play in terms of your core competitive advantage.

Additionally, some of your employees should be seen as investments instead of costs, for the long term revenue that they will bring in once fully trained and up to speed.

Most of all, there are few credible measures that relate to people and their value. We know in detail what they cost; however, we have no balancing quantity for their value. By the time we feel that asset has been lost, it’s too late to do anything about it.

Solving the Dilemma in Determining a Person’s Value

The valuation of businesses has steadily progressed over years, putting a much higher emphasis on intangible assets such as knowledge, competence, brands and systems – known as intellectual capital.

For example, one thing that occurs following a merger or acquisition of a business are lay offs of key employees, only to hire them back when the value that they contributed is recognized. More often than not, the asset that is the most important is the least understood, least prone to measurement and hence the least susceptible to management.

Ways to Measure People as Assets

There are three criteria for defining any asset:

• It must possess future service potential;
• It is measurable in monetary terms;
• It is subject to the ownership and control of the company, or it is rented or leased.

There are also traditional methods for coming to a valuation:

Cost-Based
This typically looks at the acquisition or replacement cost. The budget for recruiting an employee can be assessed and then depreciated over the expected future service of the person hired. As an alternative, the person’s gross remuneration can be used as a base.

Market-Based
The price to be paid in an open market must be a reflection of the value of a person. Value is very difficult to assess; however, and does not take account of the value of service continuity in itself.

Income-Based
The cash inflows expected by the organization related to the contribution of the human asset, calculated as the present value of the expected net cash flows. This is good for individuals whose efforts are directly related to identifiable income.

In an analysis of more than 14,000 businesses, a new study finds the most valuable companies take a contrarian approach to the boss doing the selling.  The analysis was completed by the team at The Sellability Score, an on line program developed by John Warrillow, author of the book Built to Sell, which assists business owners in assessing how well their business is positioned to sell.

Who does the selling in your business?  My guess is that when you’re personally involved in doing the selling, your business is a whole lot more profitable than the months when you leave the selling to others.

That makes sense because you’re likely the most passionate advocate for your business. You have the most industry knowledge and the widest network of industry connections.

If your goal is to maximize your company’s profit at all costs, you may have come to the conclusion that you should spend most of your time out of the office selling, and leave the dirty work of operating your businesses to your underlings.

However, if your goal is to build a valuable company—one you can sell down the road—you can’t be your company’s number one salesperson. In fact, the less you know your customers personally, the more valuable your business.

The Proof: A Study of 14,000 Businesses

The study asked 14,000 business owners if they had received an offer to buy their business in the last 12 months, and if so, what multiple of their pre-tax profit the offer represented.  Those results were then compared to the following question:

Which of the following best describes your personal relationship with your company’s customers?

• I know each of my customers by first name and they expect that I personally get involved when they buy from my company.
• I know most of my customers by first name and they usually want to deal with me rather than one of my employees.
• I know some of my customers by first name and a few of them prefer to deal with me rather than one of my employees.
• I don’t know my customers personally and rarely get involved in serving an individual customer.

2.93 vs. 4.49 Times

The average offer received among all of the businesses we analyzed was 3.7 times pre-tax profit. However, when isolating just those businesses where the owner does not know his/her customers personally and rarely gets involved in serving an individual customer, the offer multiple went up to 4.49.

Companies where the founder knows each of his/her customers by first name get discounted, with earning offers of just 2.93 times pre-tax profit.

When Value Is the Enemy of Profit

Who you get to do the selling in your company is just one of many examples where the actions you take to build a valuable company are different than what you do to maximize your profit.  If all you wanted was a fat bottom line, you likely wouldn’t invest in upgrading your website or spend much time thinking about the squishy business of company culture.

How much money you make each year is important, but how you earn that profit will have a greater impact on the value of your company in the long run.

If you’re curious to benchmark your company on the 8 major factors that drive your company’s value, take 13 minutes and get your Sellability Score without any cost or obligation

When the sale of a business falls apart, everyone involved in the transaction is disappointed – usually. Sometimes the reasons are insurmountable, and other times they are minuscule – even personal. Some intermediaries report a closure rate of 80 percent; others say it is even lower. Still other intermediaries claim to close 80 percent or higher. When asked how, this last group responded that they require a three-year exclusive engagement period to sell the company. The theory is that the longer an intermediary has to work on selling the company, the better the chance they will sell it. No one can argue with this theory. However, most sellers would find this unacceptable.

In many cases, prior to placing anything in a written document, the parties have to agree on price and some basic terms. However, once these important issues are agreed upon, the devil may be in the details. For example, the Reps and Warranties may kill the deal. Other areas such as employment contracts, non-compete agreements and the ensuing penalties for breach of any of these can quash the deal. Personality conflicts between the outside advisers, especially during the
due diligence process, can also prevent the deal from closing.

One expert in the deal-making (and closing) process has suggested that some of the following items can kill the deal even before it gets to the Letter of Intent stage:

• Buyers who lose patience and give up the acquisition search prematurely, maybe under a year’s time period.
• Buyers who are not highly focused on their target companies and who have not thought through the real reasons for doing a deal.
• Buyers who are not willing to “pay up” for a near perfect fit, failing to realize that such circumstances justify a premium price.
• Buyers who are not well financed or capable of accessing the necessary equity and debt to do the deal.
• Inexperienced buyers who are unwilling to lean heavily on their experienced advisers for proper advice.
• Sellers who have unrealistic expectations for the sale price.
• Sellers who have second thoughts about selling, commonly known as seller’s remorse and most frequently found in family businesses.
• Sellers who insist on all cash at closing and/or who are inflexible with other terms of the deal including stringent reps and warranties.
• Sellers who fail to give their professional intermediaries their undivided attention and cooperation.
• Sellers who allow their company’s performance in sales and earnings to deteriorate during the selling process.

Deals obviously fall apart for many other reasons. The reasons above cover just a few of the concerns that can often be prevented or dealt with prior to any documents being signed.
If the deal doesn’t look like it is going to work – it probably isn’t. It may be time to move on.

© Copyright 2015 Business Brokerage Press, Inc.

Photo Credit: jppi via morgueFile

Larry Lane
VR President

1. Top price at all costs

The objective is clear, just like the submarine commander who said, “Damn the torpedoes, full steam ahead.” Whether it is a public company divesting a subsidiary or a private owner, regardless if the plant is moved and the employees are dismissed, the top price is paramount. Of course, the directors of a public company will be challenged by the stockholders unless they accept the best price and/or best terms. On the other hand, the private owner has full discretion over such a decision, assuming he or she has the proper voting rights. The open auction process is the best way to ratchet the price upward.

2. High price but other considerations

The seller wants a very full price which means normally the company should be sold to a strategic buyer. However, one strategic buyer which offers $30 million and plans to move the business and replace management is less desirable than a $27 million offer in which everything is left in place.

3. Good price but some risk

The seller may be in an adverse situation in which there is extreme customer concentration, weak or retiring management and/or other mitigating circumstances. In this case, strategic buyers will often “back off,” but a large competitor will be less concerned with these matters when rolled into the total package. However, trying to sell to a competitor is fraught with risk. Risk that the buyer will renege on its initial offer, will walk away with a lot of competitive information, or will be turned down by an adverse ruling of the Scott Hart-Rodino bill (anti-trust).

4. Responsible buyer but lower price

A financial buyer traditionally does not pay the top price, but usually improves the company’s profitability by making some changes including the replacement of some management. While the status quo is more or less the same, the financial buyer’s modus operandi is usually to resell the company (often times to a strategic buyer) in five to seven years; albeit the operating management may have obtained 20-25% ownership during the interim.

5. Management buy-out (MBO) 

A management buy-out is probably the most considerate transfer of ownership with the least monetary reward to the owner. Viewed differently, if the company has significant customer concentration or acute technology dependence on management, then the best alternative might be an MBO. Because existing management usually is under-financed, it is common for the seller to take back paper as a majority of the purchase price.

6. Seller maintains control after the sale

Recapitalizations are a way for the owner(s) to payout a significant part of the company’s worth by leveraging the balance sheet. Of course, such financial engineering places considerable pressure on existing management. The private IPO as originated by Heritage Partners of Boston is a unique refinement of the regular recapitalization. It works as follows: the owner is paid for 100% of the company but then is required to reinvest on a tax-deferred basis. Heritage invests a layer of preferred stock. The remaining cash is obtained through a modest layer of senior debt. Down the road, assuming that “Newco” prospers in the future, the seller gets a major “second bite of the apple,” cashing out again at a substantial gain.

7. Sellers must stick around after the sale

In an article by Michael Selz, a staff reporter for the Wall Street Journal, he states: “The only way the owners are going to get a premium for their companies is to hang in there for a while and make sure everything goes well. Many prospective sellers want to cash out and walk. Some buyers will not acquire a company unless the owner has a substantial stake in the company’s performance for at least two years.”

Diversification is often a sound financial planning strategy for certain entities, but it may not always be the best step for building a strong company.

• How does Vitamix get away with charging $700 for a blender when reputable companies like Cuisinart and Breville make blenders for less than half the price? It’s because Vitamix does just one thing, and they do it better than anyone else.

• WhatsApp was just a messaging platform before Facebook acquired them for $19 billion.

• Go Pro makes the best helmet mounted video cameras in the world.

These companies stand out because they poured all of their limited resources into one big bet.

The typical business school of thought is to diversify and cross sell your way to a “safe” business with a balanced portfolio of products – so when one product category tanks, another line of your business will hopefully boom.  But the problem with selling too many things – especially for a young company – is that you water down everything you do to the point of mediocrity.

Here are six reasons to stop being a jack-of-all-trades and start specializing in doing one thing better than anyone else:

1. It will increase the value of your business

When you sell one thing, you can differentiate yourself by pouring all of your marketing dollars into setting your one product apart, which will boost your company’s value. How do we know? After analyzing more than 13,000 businesses using The Sellability Score, we found companies that have a monopoly on what they sell get acquisition offers that are 42 percent higher than the average business.

2. You can create a brand

Big multinationals can dump millions into each of their brands, which enable them to sell more than one thing. Kellogg can own the Corn Flakes brand and also peddle Pringles because they have enough cash to support both brands independently, but with every new product comes a dilution of your marketing dollars. It’s hard enough for a start-up to build one household name and virtually impossible to create two without gobs of equity-diluting outside money.

3. You’ll actually be found on Google

When you Google “helmet camera,” Go Pro is featured in just about every listing, despite the fact that there are hundreds of video camera manufacturers. It’s easy for Go Pro to optimize their website for the keywords that matter when they are focused on selling only one product.

4. Nobody cheered for Goliath

Small companies with the courage to make a single bet get a bump in popularity because we’re naturally inclined to want the underdog – willing to bet it all – to win. When Google launched its simple search engine with its endearing two search choices “I’m feeling lucky” vs. “Google search,” we all kicked Yahoo to the curb. Now that Google is all grown up and offering all sorts of stuff, we respect them as a company but do we love them quite as much?

5. Every staff member will be able to deliver

When you do one thing, you can train your staff to execute, unlike when you offer dozens or hundreds of products and services that go well beyond the competence level of your junior staff. Having employees who can deliver means you can let them get on with their work, freeing up your time to think more about the big picture.

6. It will make you irresistible to an acquirer

The more you specialize in a single product, the more you will be attractive to an acquirer when the time comes to sell your business. Acquirers buy things they cannot easily replicate themselves. Go Pro (NASDAQ: GPRO) is rumored to be a takeover target for a consumer electronics manufacturer or a content company that wants a beachhead in the action sports video market.  Most consumer electronics companies could manufacturer their own helmet mounted cameras, but Go Pro is so far out in front of their competitors – they are the #1 brand channel on You Tube – that it would be easier to just buy the company rather than trying to claw market share away from a leader with such a dominant head start.

Diversification is a great approach for your stock portfolio, but when it comes to your business, it may not be the next “best step” to take in building a strong company.