By Shelley Drury, CPA, CVA, ABV, CFF, Managing Director
The more valuable an owner is to the business, the less valuable the business will be. Most buyers are looking to buy a business, not a job. Although buyers generally expect to invest some labor in the operations of a business, the typical buyer is not interested in being tied to it on a daily basis.
Imagine you are selling your business and a qualified buyer must possess a unique skillset and knowledge base to effectively operate it. Imagine further that only one person in 1,000 possesses your relevant industry experience, contacts and customer relationships. Limit that pool further by the small percentage of those individuals who would consider small business ownership, and you have yourself an extremely limited number of potential buyers.
Alternatively, if a seller has limited day-to-day duties and the business is managed primarily by employees, the pool of potential buyers has just been expanded tremendously. The buyer does not need to possess significant specialized industry knowledge or labor to effectively run the business. By accomplishing this, sellers make their business more valuable, marketable, and attractive to potential buyers.
Following are ways business owners can reduce key person risk and increase the value of their business:
- Keep the owner’s day-to-day functions to a minimum. If the seller’s labor is necessary to market new business, fill orders, serve customers, direct employees, or manage other operations, the buyer has to replace those critical functions with either their own labor or that of one or more employees with specialized experience. The experience, industry contacts, and customer relationships of the seller are especially difficult to replace and require a substantial time investment on the part of the buyer. Again, most buyers are looking to buy a business, not a job.
- Ensure the business generates sufficient cash flow to permit absentee ownership. Suppose the employees handle enough of the operations so the owner does not need to be involved in daily operations, but the payroll cost to accomplish this objective leaves the owner with no discretionary earnings at the end of the year. Technically, this would be considered a “job,” not a business, as owners expect returns on their investment in a business. Excess cash flow, beyond a market owner salary, is necessary for absentee ownership to be a viable consideration.
Most absentee-owned businesses are successfully operated by a team of qualified employees and managers. When preparing for sale, owners should focus on building a business that can be run independently of them, thereby making it more scalable. This scalability, or growth potential, is that key component that strategic buyers are seeking to maximize their potential return on investment.
To make themselves replaceable, owners should focus on streamlining their business by developing a strong management team, investing in automation, and documenting processes. Additional efforts in marketing should be considered to grow the business and generate the excess cash flow required to facilitate absentee ownership.
For more information about business combination accounting or assistance with preparing for a business sale, contact your PKF Advisory team member or:
Shelley Drury, CPA, CVA, ABV, CFF