Running your business involves taking hundreds of actions every day, whether negotiating a sale, recruiting a new employee or complaining to a supplier. Much of the working day is spent reacting to circumstances, making minor decisions that have a limited, short-term impact.
In contrast, creating a valuable business is about taking strategic decisions that have a lasting effect. Unsurprisingly, this is easier said than done. But for many directors, particularly those who own a share of the business, it must be the ultimate aim.
1. What is value?
A valuable business typically offers growth, profitability and security
- Banks are more likely to support a business with a positive cash flow.
Creating a valuable business generally requires a medium- or long-term strategy
- In the short term, creating value usually requires investment.
- Short-term methods of increasing cash flow and profitability can reduce your potential for creating value in the long term.
- Long-term strategies are usually riskier. Their eventual outcome is more uncertain.
- If you plan to sell your business, its value will be higher if you can show a track record of strong strategic actions over time.
Different stakeholders may have conflicting objectives
- Some shareholders value a business that offer secure or gradually increasing dividends. Other shareholders may accept more risk for higher growth potential.
- Directors and employees may have their own agendas (eg generous contracts, career opportunities or job security).
- The local community may value a business that is environmentally responsible, or contributes to the community in some way.
- Ideally, your strategy will take all these interests into account.
Your strategy will have a better chance of success if it includes measurable objectives
- These are likely to include ways of measuring value for the business overall.
- Set intermediate targets for what you aim to achieve in different areas of the business.
- Include realistic timescales for the completion of these objectives.
A traditional valuation method is based on a multiple of sustainable earnings
- The size of the multiple reflects your growth prospects.
- There are also valuation methods based on assets and cash flow.
- Particular industries have rules of thumb for measuring value (or potential value) - for example, the amount of floor space a retail business has.
You can use the cost of recreating a business from scratch
- This often provides a good indication of the value you have built up. It is particularly appropriate for young, growing businesses that are investing heavily to build future profits.
- The figure will be misleadingly optimistic if the investment does not turn out to be as worthwhile as hoped. For example, companies that ‘buy’ market share will not create value unless they can retain customers and grow profitability.
Operating in an expanding market makes it easier to grow your business
- If you are operating in a market that is stagnant, or in decline, you may want to exit the business or merge with competitors. Larger companies are usually in a better position to exploit mature markets.
- It is difficult for a small business to create market growth.
Create a business which can be scaled up
For example, you might aim to:
- expand into other geographical areas;
- acquire smaller competitors;
- franchise the business.
A narrowly-focused business is the most likely to create outstanding value
- It is easier for a focused business to pursue its goals relentlessly.
- However, this type of business is also most at risk of failing. Diversifying into related products or businesses that suit your strengths can reduce this risk.
- Outsourcing non-core activities can improve your business’ focus. But you risk losing control.
Strategic alliances can be an important source of growth
Alliances can be particularly helpful if you do not have the resources to exploit your opportunities fully. For example:
- Working with a distributor may be more effective than developing your own sales channels. Tying in key partners in this way also reduces the risk of losing business to competitors.
- You might want to involve a partner in exploiting your intellectual property - or you might want to sell or license the rights.
The key to growth is marketing
- See Marketing.
Businesses that are relatively stable are usually considered more valuable
- A business with volatile profits is less valuable than one with fairly predictable year-on-year increases.
Assets can be a significant element of security
- Intellectual property can be an important contributor to value. This is particularly true in the IT industry, where ownership rights to software and products are a major issue.
- Freehold or long leasehold property can provide capital growth as well as security.
- Your customer mailing list may have significant value.
The value of assets needs to be protected
- Maintaining assets helps generate value, while failing to do so can destroy it.
- Intellectual property should be patented, copyrighted or trademarked.
The higher the value of your business compared to your assets, the greater the risk
- All intangible value needs to be protected. For example, in a ‘knowledge’ business whose value largely reflects the skills of its employees, the business risks losing value to turnover.
- Protect your customer database and other key records by creating back-ups and keeping them off-site. Back up data on your IT system.
The ability to anticipate change is an important way of protecting value
- Set up systems to monitor the business climate. You need to be aware of forthcoming political, economic, social and technical changes (eg changing customer needs).
- Systems that allow you to anticipate problems and plan ahead will help you create a strong, consistent track record.
Tying in value
You may be able to make some of the intangible value of your business more concrete
- One way of achieving this is by building a strong order book. Differential pricing techniques can help create advance sales.
Use contracts to protect value
- Employees’ contracts can prevent the leaking of trade secrets and limit employees’ ability to entice clients away from you.
- You can use long-term contracts to guarantee the supply and price of crucial materials.
Relationships can be more powerful than contracts
- A good working relationship is a better way of ensuring employee loyalty than a restrictive contract.
- Good customer relationships can have a more enduring effect than any sale contract.
Aim for market leadership
- Greater market share can create a virtuous circle, with increasing turnover providing economies of scale and high visibility making it easier to win more customers. It also makes it easier to attract and retain employees.
- No matter how small, any business has the potential to differentiate itself from its competitors and become the market leader in a defined niche.
Create a brand which captures the essence of your business
- What does your product or service offer that sets it apart from those of your competitors? This is your unique selling proposition (USP) and is the basis of successful branding.
- A brand helps you maintain the important ingredients of your business as you grow.
- A brand helps you interest existing customers in new products.
- A powerful brand can be extended as you diversify (eg Virgin).
- Trademarks can be an important part of your branding.
You may be able to grow by changing your market positioning
- a hotel might grow by moving upmarket, gradually improving its facilities, standards and prices;
- a specialist engineering business might grow by moving downmarket, developing cheaper, mass-market versions of its market-leading products.
Above-average profitability and growth usually attracts fierce competition
- Protect your market with strong customer relationships.
- Protect any intellectual property that helps you outcompete others.
- Use market research to keep in touch with your customers’ needs.
- Continue to innovate and avoid complacency.
Make your firm an attractive place to work
- Provide good working conditions.
- Offer competitive salaries and benefits.
Strengthen your personnel resources through recruitment and training
- experienced directors who make creating value a priority;
- managers with transferable skills to manage growth;
- employees who help you achieve market-leading standards.
Make sure employees want to increase the value of the business
- Communicate your strategy and encourage employees to buy in to it.
- Use incentive pay to align remuneration with creating value.
Set up systems to minimise the risk of employees ‘owning’ value
- For example, sales people may control customer relationships, expert employees may be the only people with important company skills and managers may command the loyalty of their entire team.
- You may want to include clauses in your employment contracts to prevent former staff from competing with you.
- Systems that make sure knowledge is shared, encourage teamwork, and make employees easy to replace are vital.
Retain key employees
- The individuals who have created a valuable business will themselves be an important part of that value.
- Provide opportunities for career progression within the company.
- Allow them an appropriate share of the value they create.
Invest in your operations
- You may need to invest in research and development for new products. You may qualify for a research grant or tax credits. Contact your local business support organisation.
- Outdated facilities and technologies will harm productivity. This hidden negative value can suddenly become apparent when a competitor overtakes you.
Streamline operations and create standard policies and procedures
- Simple, smooth-running processes are easier to use as you grow.
- Continually having to make one-off, ad-hoc decisions limits your ability to grow. Firms with a very hands-on owner-manager are particularly susceptible to this limitation.
Build management information systems to monitor the business
- Identify weaknesses and risks, and take steps to protect yourself from them.
Ensure that you have adequate financial resources
- Make sure that working capital limitations do not restrict your growth.
Build your financial status
- Use the right mix of debt and equity to make the business creditworthy.
- Behave in a creditworthy fashion. Pay lenders and other creditors on time.
- Make sure investors and lenders are kept informed, and are given advance warning of any likely disappointments or problems.
Borrow sensibly and sustainably
- set up borrowing facilities in case of need;
- borrow at fixed rates;
- ensure that meeting your repayments is a priority.
Work to minimise debt
- Ensure that as a long-term strategy you strive to keep your costs down.
"Pay attention to contractual matters. Business owners often regret not looking at the details of the contract early on." - Brian Hayden, Hayden Associates