Understanding the value of your business: Part I

By Mark Wardell

Having worked with business owners of all kinds for close to 20 years, I have learned that, pretty much universally, entrepreneurs have a difficult time understanding what it is that makes their businesses truly valuable. Value is an illusive measurement. Revenues, assets, profits, and so forth, are all fairly simple to read from financial statements. But value is a tough one. This is particularly the case when a business is sold. Why is it that two seemingly identical businesses sell for different amounts?

The most effective way to understand the value of your business, is to understand your “goodwill.” If you aren’t familiar with the term, goodwill describes the value of a company, over and above its liquidation value. In other words, goodwill is what forms the better part of the owner’s “profit” when it’s time to sell. There are essentially two types of goodwill: business goodwill and personal goodwill.

Business goodwill is the portion of a business’s value associated with the business itself.  It includes things like brand recognition, location, procedural manuals, market share and so forth. And since business goodwill is transferable from one owner to another, it is sellable.

On the other hand, personal goodwill is the portion of a business’s value associated directly with its owner. Things like the owner’s name, reputation, contacts, skills and abilities. For many small to mid-sized businesses, the majority of value is tied up in personal goodwill. Unfortunately, personal goodwill only has value to the current owner, and is therefore unsellable.

All things being equal, a company with a higher percentage of business goodwill will attract a higher price than one with a higher percentage of personal goodwill. From the buyer’s perspective, a company with a large amount of business goodwill is worth the higher price because the customers are more likely to stay and the business is more likely to remain profitable once it has changed hands.

What this means for your business: Your goal should be to transform as much of your personal goodwill into business goodwill as possible.

I use a valuation tool to help business owners pinpoint specific areas of both strength and weakness in the areas of Leadership, Management, Marketing, Finance, Operations and Sales. While I can’t perform a complete diagnostic of your business in this column, I’ll provide a series of questions on Friday designed to help you understand how to strengthen the saleable components of your business, in order to achieve:

1. A more solid, less owner-dependent operation.

2. A more secure investment opportunity for stakeholders.

3. A significant increase in market value.

Stay tuned for Part II of Understanding the value of your business on Friday.

Mark Wardell is President & Founder of Wardell Professional Development (www.wardell.biz), an advisory group that helps business owners plan and execute the growth of their companies. The author of seven business books, Mark also writes regularly for several national business publications, including Profit Magazine, the Globe and Mail, and CGA Magazine. Email him at [email protected]

By Adam

August 10, 2011