“We know that business owners ultimately care about one thing: wealth creation” - Trevor Greenway.
Why do people become entrepreneurs? Ultimately, there are two reasons, one altruistic and one pragmatic, and both are necessary for deciding to become an entrepreneur.
Altruistic reason: they are passionate about providing a particular service or product to people that, in your opinion, want (and ideally need).
To do this though means taking a risk - potentially not getting a pay cheque, personal guarantees on debt, personal liability for remittances, etc.
And this leads to the other side of the cost-benefit analysis of becoming an entrepreneur.
Pragmatic reason: to create wealth for themselves by providing that service or product.
So, how is it that 98% of business owners (according to a CNBC survey) do not know the value of likely their most valuable asset - their business?
The answer has historically been it is a complicated subject matter and expensive to find out on an on-going basis.
With advancements in technology, this information is being democratized and more easily produced on an ongoing basis. This addresses the expense to find out, but it doesn’t necessarily address the complicated subject matter.
There still needs to be a professional advisor (whether that is an accountant, a banker, or a wealth advisor) to convey what it means and what to do to grow that value. However, because of the complexity and because it is not traditionally a core part of the advisors’ job, they don’t even know how to talk about it. In fact only 20% of accountants actually formally talk to their clients about business valuation on an annual basis (and it must not be that effective, because as noted above 98% of business owners do not know the value).
So here are some best practices for talking about business valuation with your clients:
- Set the expectation of why it is being discussed - an informal business valuation is meant to be a diagnostic tool, and to establish a benchmark to measure against. It is to see if all those hours and all that risk is producing anything of value or not.
- Recognize that there is a range - part of the reason advisors hesitate to talk about valuation is they don’t want to be held to a specific number. Giving a range, even if it’s 20% spread between the high and low, it is something. This isn’t going to be litigated against or used in a divorce proceeding (that’s when a formal valuation report is needed!).
- Explain calculated vs market value - business valuation is ultimately a math exercise. There is some professional judgment or ‘art’ needed with the science, but it is based on what a set of financial statements or financial projections say. That is different from what someone is willing to pay in a transaction. There is a correlation between these two, but there are other qualitative factors that impact the market comparisons. These can be highlighted or discussed in a non-financial way (what makes the business more or less attractive to a buyer) but is not part of the math exercise.
- Present it in a digestible way - spreadsheets with lots of numbers is what advisors, particularly accountants are good at. It is drilled into accountants for example to ‘show their work’ for review purposes internally. However, finding a visually appealing and interactive way to present the business valuation is key for the business owner to grasp it.
- Relate valuation to goals - the response to the value of a business is entirely dependent on what the business owner thinks or wants the number to be. The conversation and opportunities that come out of it for advisors is greatly impacted by whether the client is disappointed or excited by the valuation. Anchoring the valuation against their goal and their timeline is important. When doing so, looking at the growth rate needed to achieve their goal, and comparing that to their current growth rate, will allow for a more meaningful conversation.
- Start long-term then narrow the focus - Now that there is a long term goal to pursue, the next step is to narrow the focus to ‘what can be done now to reach that goal?’ This is where advisor opportunities come into play. Perhaps it’s using excess working capital to generate investment return for wealth creation, or planning to minimize tax, or discussing whether debt financing makes sense to facilitate business growth. This is how the business valuation conversation transitions into discovery and a natural upsell for the advisor, because the services recommended are tied to the achievement of their goal.
By following these tips, the challenges of talking about the most important business KPI can be overcome, and can in turn position any advisor as the business owner’s ‘go-to’ for helping them meet their long-term goals.
Author: Dave Bunce CPA, CA
Director of Partnerships, interVal