EP 24: Frequently Asked Question Friday Jan 17, 2020

Ed Mysogland  0:01  
Please welcome please welcome welcome. This is another episode of the defenders of business value podcast podcast where we talk about what makes a business valuable learn the tips and tactics to increase your company's value that only veteran dealmakers know. And now here's your host it miso clamp. Welcome back to the defenders business value podcast. I'm your host, Ed Mysogland. I help business owners understand the value in their companies so that they can sell when they want how they wanted to whom they want. Last week, was our first installment of frequently asked question Fridays, based on the feedback, it was well received. So we're going to continue with this. And this week, we have three new questions. So let's get to it. The first question is how to value a business? That's a That's a tough one. So it depends on the business. But let me see if I can help you a little bit on your question. So there's three approaches to valuing any business the asset income and market approach. The first one the asset approaches, as it sounds, its focuses on the components of the company. So that tangible intangible assets, and you value them individually, and you add them together to come up with a value now, it typically renders the lowest value, but I tend to only use it when I have an underperforming company. And there's not a whole lot of goodwill associated with the company. The second one is the income approach income approach is based on forecasting I, in the space that I work in. Small Business forecasts are extremely difficult. And they're only, I guess, I should say, the only time I ever use them as if my client has a history of being able to forecast accurately, their next two to three years. And even that's not enough. But that's a conversation for another day. But what the takeaway is, it's based on forecasting, so if you don't, if you are unable to forecast with any degree of certainty, it's probably not the approach for you. The last one, and I and I spend most of my time using it is the market approach the market approach is based on as it sounds, we use privately held sale data and apply it to the company we're valuing. So we look at revenue, cash flow, and we apply it to the company we're valuing. That serves as a proxy for value. As much as I don't like the analogy, think of the market approach as valuing a home. So you, you see other homes with four bedrooms, two baths, within a certain area. And you can apply what you've learned about those homes and apply it to your home to get kind of a rough estimate. Well, the same thing you can do with a business, the the challenge that we have is, is market data. But if you listen to my podcast with Kenny Wu and Adam Manson, from deal stance, you'll hear how we get that information and how we apply it. The next question is, from a person that well, let me just read the question. How do I know if I have a customer concentration issue? I have one client that represents 40% of my total revenue, will I be able to sell my business? As I've indicated, on the podcast, and most businesses are saleable at some price and the challenge becomes a matter of risk and reward and identification of value. In the case of customer concentration, we we bump into how does the buyer mitigate that risk? Because post sale, they don't know what's going to happen whether or not that that buyer or whether or not that customer is going to stay with them was the relationship with with with with you as the owner or how does that how does that work? And so if, if I'm a buyer, I have to come up with a way to mitigate that risk. And typically it's, it's done through earnouts otherwise known as if then fit financing. So if x y and z happened I'm I will pay you x. So, so yeah, that's the that's the challenge with customer concentration. So now let's address the 40%. So as you examine the 40%, I think the first couple things that you need to examine is where is your profit coming from? So you and for example, we had a client that lost 20% of their, their business, but it was making up 40% of their profitability. So it was a it was a considerably bigger hit. So my, my, my comment to you, or my suggestion would be dig deep into that customer and see how valuable they are to your business. So now addressing the saleability matter? Yeah, I think I think it is, but I think you need to understand that so long as there's a customer concentration challenge that the buyer is going to have to mitigate that risk. And that's going to spook the lenders, it's going to spook the buyers. So what what do you do, the first thing you can do is anticipate that the buyer is going to make part of the purchase price contingent upon retention of that customer. So you may have to alter some of your post sale plans in order to accommodate that transition. Second, you may have to stay with the business, you know, an elongated time to ensure that the that client or that customer has transitioned over to to the new buyer, you may want to deploy some sort of incentive program for those within the organization or the your salespeople that can help you diversify that customer base. Anyway, I'm not going to sugarcoat that it is a challenge and one, one of which is surmountable. But you're just going to have to understand that it's going to take a little bit more than than the normal deal in order to get out from under it. If you are looking for some some ways to diversify your customer base, email me offline at edit defenders of business value, I'll do what I can do to help you out. Okay, our final question is, which is more valuable, a franchise or an independent, small business? And unfortunately, it's one of those things where I have to say it depends. So some buyers prefer that the independent businesses, whereas others are just the opposite, they need a system that has been worked out that that they simply can follow. And if they do everything they're supposed to do, they should be able to turn a profit. Well, let's take a look at some of the attributes related to independence as well as franchise businesses. So the ownership model is the first thing. And when we look at it, you know, franchises are a system, I mean, the infrastructure is put together and there's an everything's been systematized, whereas a independent business may not be systematized. And so it requires the owner to put in more effort in order to to operate the business effectively. If you have ever read Michael Gerber's, E Myth, or E Myth revisited, you'll see that I mean, that's, that's one of the things is systematizing the business so it's documented, almost operating like a franchise. The next thing you have to consider is size. I mean, when you have when you're an independent, I mean, you may have you may have the corner on a particular type of service or product that you're selling. But when you look at a franchise, for example, you know, chances are they're probably a national national brand, and they have better name recognition than you you might you have local presence, they probably have national presence. Probably the last thing that I would I would bring up is the success rate. I mean, that proofs in the pudding. So when we look at both types of businesses, I think you find that there is it's debatable whether or not one type of business is more successful than the other. And you have to evaluate the each business based on its merits. I was speaking at an event the other day and

they brought up the topic of subways. So if you took a Subway sandwich shop that was is generating $200,000 in profit and you have Joe's sandwich shop that's generating $200,000 in profit, which is more valuable. Likely it's the subway because the subway has less risk associated with it and that would be reflected in the in the multiple. Okay, that's all the questions for today. If you have a question you can go to defenders of business value.com And all throughout the website, including right down the sidebar, there is a ask a question, just click it. And you can follow the directions and either record or submit a question and we'll put it on the air. If you'd like to contact me directly, you can do so at edit defenders of business value. Or you can reach me on Twitter at Ed miso m y. So, thank you so much for your attention, and we'll see you next week.