How to Grow the Value of your Business Goodwill?

With the Sochi Olympic Games taking place this month, it is interesting to reflect back on some of the big events of the 2010 Winter Olympic Games in Vancouver, Canada.

In the Men’s Downhill race at Whistler, for example, the winning time of 1:54:31 was posted by Didier Défago of Switzerland. The time among medallists was the closest in Olympic history, and while Mario Scheiber of Austria posted a time of 1:54:52 – just two tenths of a second slower than Défago – he finished out of the medals in fourth place.

In ski racing, one fifth of a second can be lost in the tiniest of miscalculations.  And when it comes to selling your business, markets can be equally cruel. Get everything right, and you can successfully sell your business for a premium. Misjudge a couple of minor details and a buyer can walk, leaving you with nothing.

Most of the value drivers are intangible factors which make up part of the value of a business The Goodwill

Like competing in the Olympics, selling a business can be an all-or-nothing affair. Get it right and you will walk away a winner. Fumble your preparation, and you could end up out of the medals. To grow the value of your business you have to reduce risk and insure business continuity with or without you by:

  1. Transforming personal (and individual) goodwill into business goodwill
  2. Maximizing business goodwill value acting on both External and Internal factors

– External factors are the changes in worldwide/regional/local economies, technological changes, governmental and regulatory changes. You would say that a business has little impact on those alone but you have to understand and embrace those changes very early on to make sure your business  always has a competitive edge.

– Internal factors are linked to employees and other stakeholders (customers, suppliers, shareholders, partners…), existing business systems and processes, leadership, management, marketing, finance, operations, sales

How much growth is possible? In most cases goodwill value can be systematically doubled or even tripled in 3 years or less

How do you grow value? A general way to value a business is a multiple of net profit. While this is only one of many, it is a common practice and obviously every business can be analyzed using a simple multiplier method.

Three ways to improve the value of the business:

–          Add profitable turnover

–          Increase net profitability percentages

–          Increase the profit multiplier – This is about risk and chance of continued earnings for the new owner (mainly goodwill)

Simply growing profit by 10% year on year will increase the value of your business by 33% (from 1,250,000 to 1,663,750) in three years as shown in the table below:

Year

Normalised Earnings £

Earnings Growth Rate

Earnings Multiple

Estimated      Value £

Benchmark

500,000

2.5

1,250,000

Year one

550,000

10%

2.5

1,375,000

Year two

605,000

10%

2.5

1,512,500

Year three

665,500

10%

2.5

1,663,750

If you also work on the multipliers (more goodwill) the effect is exponential. In our example below it could reach 113%!

Year

Normalised Earnings £

Earnings Growth Rate

Earnings Multiple

Estimated      Value £

Benchmark

500,000

2.5

1,250,000

Year one

550,000

10%

3.0

1,650,000

Year two

605,000

10%

3.5

2,117,500

Year three

665,500

10%

4.0

2,662,000

How do you calculate the goodwill?  Fair market value – tangible assets = goodwill

Year

Normalised Earnings £

Tangible Assets £

Goodwill Multiple

Estimated    Goodwill  Value £

Benchmark

500,000

750,000

1.0 x earnings

500,000

Year one

550,000

800,000

1.5 x earnings

850,000

Year two

605,000

900,000

2.0 x earnings

1,217,500

Year three

665,500

1,000,000

2.5 x earnings

1,662,000

In our example above   the benchmark Goodwill equal £1,250,000 – £750,000 = £500,000 in year three it is £2,662,000 – £1,000,000 = £1,662,000 a 232% increase!

Where does the growth come from? Let’s have a look at the Value Pyramid:

value pyramid

–   An owner driven business. In this type of business, the owner makes it all happen. Because this level of business is highly reliant on its owner, the risk of a business losing its profitability following a succession is highest. This business is not yet ready to sell. A potential buyer would certainly value the company below 33 % of its potential value.

–   A people driven business. In this scenario, key people in the company, other than the owner, make the business happen. At this level, succession-related failure is reduced, but still plays a role due to the fact that the key people could leave, and thus take valuable information, and even customers, with them. This business is almost ready to sell but a potential buyer would value this business at less than 66 % of its potential value.

–   A process driven business. This type of business is run by systems, which greatly reduce the risk of failure after a succession. At this level, systems are in place to ensure that operations continue according to plan, with or without the owner or key employees, so the business is set up fairly well to run itself. This type of business has more inherent value than the first two levels, and from a value perspective, is in sellable condition. And could reach up to 90% of its potential value

–  A culture driven business. In this environment, the culture (driven by both people and systems) make the business happen. Level Four is considered as close to a pure “investment” as a business can come. Its culture indoctrinates new hires into an environment of continuous improvement, based on systems. The result is what we call, a “Culture of Excellence”. This type of business has the least chance of succession related failure, and is therefore considered the most valuable to a prospective buyer.

Get your Sellability Score. Take 13 minutes to answer the Sellability questionnaire now. You’ll see how you performed on the eight key drivers of sellability and you can identify any gaps you need to fill before taking your business to market

If you have a question or disagree with me please leave a comment on this blog.  I will respond promptly so we can have a fruitful discussion

If you like this article please share this link with your friends on social media, your Blog or by e-mail

If you envisage to transition out of your business in the near future and would want to explore what you should do please do not hesitate to call Jean-Bertrand de Lartigue on +44 1656 766 363 or e- mail him at JB@macint.co.uk

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