Treating a Business Like a Portfolio: How to Maximize Return on Investment
Everyone likes to maximize the value and annual return of his or her investments. Investors hire the best advisor they can find to monitor their marketable securities. Few business owners, however, manage their most important asset with that same level of commitment.
Closely held business owners get into the trenches and can be overwhelmed just handling the day-to-day responsibilities. As a result, they often do not have a realistic idea of the worth of their business or the type of return they are achieving.
But just like a stock portfolio, a business requires close oversight to create greater wealth. Most investors pay a fee of about 1 percent of their portfolio value to an advisor who tracks their assets. Investing a similar percentage of the value of one's business into tools and expertise to grow its value should be just as important.
Typically, 50 percent to 70 percent of an owner's net worth is tied up in the business. Taking time to scrutinize it with an "investor mindset" has helped some owners double the value of their companies.
Here are five steps any business owner can use to evaluate his or her firm and put it on the path to success.
The investor mindset should start with a valuation to determine what the business is worth. Just as investors receive quarterly or annual statements on their stocks and bonds, business owners should repeat the valuation annually to track changes.
The business valuation becomes an important part of the company's strategic planning. It allows owners to make better decisions about their futures-such as gifting stock or selling the business-by being proactive, rather than reactive.
Once the true value is known, take steps to increase the return and make the company more valuable. The top three drivers of business value are:
• Rate of return - Investors view risky businesses as less valuable. Owners must identify risks and take steps to minimize them to maximize investors' profits.
• Sustainable growth - Continued growth adds value to a business. Owners should closely monitor growth and develop strategies to create and manage sustainable growth.
• Cash flow - By increasing gross margins and decreasing operating expenses, sustainable cash flow rises, resulting in a higher value.
Although not required of private companies, professionally prepared financial statements allow owners to measure the business against generally accepted reporting practices and lower risk through the eyes of an investor. Such statements make the business more attractive when seeking financing or potential buyers and can be used to compare the business against industry benchmarks.
Buy-Sell, Contingency Plans
Review the company's buy-sell agreement and your "what happens if a key player gets hit by a bus" plan. This business owner "will and testament" details what will happen if an owner dies or becomes incapacitated. Review it annually and update it with the business's value as well as any shareholder changes.
If the company purchased life insurance policies for key shareholders to fund the agreements, verify the amount of required insurance and adjust if needed.
Develop an Exit Plan
The investor strategy should include an exit plan for leaving the business. This can hinge on the owner's personal financial and estate planning efforts. The annual business valuation can help determine realistic goals. With values lower in the current market, gifting options may help maximize tax benefits.
Succession planning can be complicated. It involves the owner's goals as well as those of family members and other key personnel, mixed with the realities of family dynamics and the business situation. It's a discussion that must take place so the business can continue to successfully function. There may be multiple exit options, so enter discussions with an open mind. Depending on the situation, an owner might choose to gift the business to family, or sell it to employees or a strategic buyer.
Demographics project a mass exodus of baby boomers leaving their businesses in the coming years. Many will be trying to sell their life's investment to a limited number of buyers. Competition will be fierce. Increasing the value of one's business will help owners position themselves for this buying frenzy, which is expected to occur once the economy rebounds. Begin the process by working with a valuation professional who is experienced in succession planning and mergers and acquisitions.
Although it may not look like stocks and bonds, a business owner's money, time and passion are tied up in his or her largest asset. Why not take steps to maximize the return and get the most from all you've invested?
Tim McDaniel, CPA/ABV, ASA, CBA, is a shareholder in the Dublin office of Rea & Associates Inc. He can be reached at (614) 889-8725 or firstname.lastname@example.org.
Reprinted from the November 2010 issue of Columbus C.E.O. Copyright © Columbus C.E.O.