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Focus on quality to build value, and profits will follow

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Owners of privately held businesses are leaving dollars on the table because they are focused on income generation and not focusing on enterprise value.

Income does not automatically translate to value. It is an unfortunate fact, but most businesses are not salable, and, if it is a family business, it doesn’t survive beyond the second generation.

Is this a problem or opportunity?

According to the Exit Planning Institute, an education company based in Cleveland, the average privately held business in the United States has around $5 million in sales with an average enterprise value of around $2.5 million. In addition, there are around six million privately held businesses with paid employees.

Only 20 to 30 percent of this total will transfer into any value, according to the Exit Planning Institute.

For the 70 to 80 percent of businesses that are not transferrable, you will find that $8 trillion to $9 trillion of value may be lost because of privately held business-owners being unprepared for transition. The social and economic consequences are enormous.

There are several reasons why owners are not proactive in planning their exit:

< Scared (don’t know what they don’t know).

< Trapped (dependent on lifestyle and maintain a low-income tax profile on business).

< Personally unprepared financially.

< Don’t know what else to do.

< Misinformed.

< Planning takes time and is complicated.

< Have advisers that are not organized to work as a team.

WHAT A BUYER WANTS

There are a process and structure in planning for transition. The owner who seeks help in navigating this can significantly improve the chances of realizing enterprise value when transitioning from the business.

To get what you want, buyers need to get what they want. What they want is a business with a best-in-class combination of low risk and high profit.

You may feel your business is low risk because you have been managing it for many years, if not many decades.

But to a third party which may require bank financing to buy your company, will your business be bankable?

FIVE-YEAR PLAN

For family transitions that may not require bank financing but carry debt with a bank, there is going to be a “bankable” moment when the next generation is required to personally guarantee company debt.

Most privately held companies have an opportunity to double their value over three to five years by adopting a disciplined, methodical approach to reducing company-specific risk while increasing quality.

If one can identify as many risk areas as possible, assess them objectively and dynamically link assessments to the calculation of business enterprise value, you can use the process to maximize value through risk reduction.

PUBLIC COMPANY BLUEPRINT

We can more clearly see how risk is managed in a company by looking at how publicly held companies address risk. Public companies can be viewed as less risky – not only because they have to be well-organized in order to go public – but also because they have worked on key metrics of their business that lead to less risk.

Privately held business owners may have worked on some of these metrics – but rarely all of them. And that’s simply because they find they have no reason because of their focus on income as opposed to focusing on enterprise value.

Public companies know that in order to attract capital, they need to grow enterprise value while reducing risk. Here’s how:

< Creating strong management teams.

< Providing greater transparency.

< Establishing good organizational structure.

< Developing comprehensive and written business plans.

< With document systems and procedures.

< Building effective market and brand position.

< With ongoing robust product development.

< Continually reviewing organizational and financial emergency management plans.

MISCONCEPTIONS

Many privately held business owners believe the most effective way to build enterprise value is to do one of three things: grow sales, cut costs or make acquisitions. Each of these strategies, though, may increase risk to the company.

Growth can consume capital, strain an organization, damage company reputation and erode value.

Cutting costs can undercut the ability to support long-term growth, hurt a company’s market position and destroy long-term value.

Acquiring another company on top of a weak infrastructure may cause failure to both the acquired company and the core business.

Ultimately, chasing quantitative results can adversely affect the organization and its enterprise value.

QUALITY FIRST

Focusing on the qualitative factors that drive quantitative results may align and strengthen the organization, improve profitability, enhance growth potential, reduce overall risk and maximize enterprise value.

Most privately held business

owners have 80 to 90 percent of their personal wealth tied up in their business.

And with $8 trillion to $9 trillion of privately held business’ value at stake, there is no better time than the present to get started.

Based in South Whitehall Township, Jan Graybill is a Certified Exit Planning Advisor and managing partner of Legacy Planning Partners, a company he founded in 1999. For 37 years, he has made business owner transition planning the focus of his client practice. He can be reached at jgraybill@legacy-online.com.

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