Maximising Your Business Value: The Importance of Valuation for Entrepreneurs – with Kevin Harrington

Welcome to the podcast that’s dedicated to helping business owners prepare for exit so you can maximize evaluation and exit on your terms. This is the exit insights podcast presented by succession plus I’m Darryl Bates- Brownsword. And today we’ve got something a little different for you.

Today we are bringing in my business partner, Kevin Harrington. Kevin and I did an episode like this once before in the early days. And I guess it’s fair to say, Kevin, that we got really good feedback. So we haven’t done it again since. Yeah, summed it up quite nicely.

How many podcasts have you done since that one? Well, we’ve done nearly 100 episodes now, so we’re doing two or three a month. So we’ve kept the habit going and we’ve built it into something. The listeners, the background has changed somewhat since we first started. When we launched the podcast, perhaps naively, we thought the audience would be UK based, primarily UK based, and we’ve got a lot of UK listeners, and because a lot of our early guests were UK, and our primary markets was just focused on the UK.

But over the time, we’ve had guests from a lot from the US, some from Australia and some from other parts of the world. And here’s an interesting stat for you. Where do you think our number one listener base is, Josh? I would imagine that it’s probably the United States by now. Singapore.

Okay. Yeah. So I did some research recently, and surprising, and I think it was because we had one or two guests from Singapore, really quality information, and I guess they shared it with their networks. They’ve been avid listeners ever since. So there you go.

You can’t control your audience. As you say, the States is pretty big and the UK is pretty big, and Australia is picking up there as well. And you’d like to think that given we’ve got a fairly big footprint in Australia, but today, the reason for asking you to join me today is last time we did this, Kevin, we got a lot of really positive feedback. The feedback was kind of love it when you get guests on the show, love it the way you summarise and pull together the thoughts and have a bit of a rant. But we really liked it when you and Kevin came together and sort of bounced off each other and shared and discussed some of the things that you’re working with on clients.

Obviously, it was all confidential, but some of the themes that were coming out. So we thought we really should get together and do this more regularly. So we’ve scheduled it. This will happen in the future. We think about once a month about right as the way forward.

So let’s see what happens. And today, in preparation, we’ve got a bit of an agenda, but something that’s been coming up regularly for us is questions going. Hey, look, guys, I love the idea. I think planning for exit and getting my business ready for exit is a really good thing. I just have no plans to exit my business in the next few years.

Why should I prepare my business for exit now? Why should I get my business exit ready before I’m even thinking about exit, before I’ve got any plans to exit? I’m really concerned about what my employees will think and a million other questions. Is this something that you see on a regular basis? Yes.

As you were introring there. Suddenly in the forefront of my mind is a good friend of mine who you have briefly met in the past who wants to exit his business which is an interior design and he never planned ahead to exit his business and just doesn’t know how much. I said how about doing this, how about doing that? As friends, we never really got around to helping and sorting things out properly. And then pretty much at the last minute about six months before he wanted to be out of the business an M and a firm phoned him up and said we can sell your business.

Let me tell you what that process looked like his unplanned attempt to exit. They came in and said course we can sell that. Yeah, we do businesses like this. They took 3000 pounds off him, took photographs that had to be reshot because they were so bad. Wrote a description of the business that was so far off beam that I ended up writing it.

And they put it on their website under DIY shops because they didn’t have a category for the area they thought that was so good. And at this moment in time they’ve had no inquiries at all. And waiting 45 minutes on the phone to try and get hold of these people. They can’t get hold of them. He’s getting now to the point where he will be out of the business fairly soon and no plan, no choices, no direction and it’ll just be a fire sale at the end.

And that is all. Because there was no forethought planning anything like that. It’s frankly a crying shame but enormously common.

Yeah, it is enormously common and I think you’ve sort of hit it there. We wait and we react when something comes our way. A lot of business owners say to us hey look, I’ll build my business to a point and I’m getting M and a people brokers on my door all the time banging, offering to sell my business. When the timing is right, I’ll just talk to one of these guys and end up with a similar experience to what you’ve just had. The point that I want to pick up on that you said that you dropped in there probably nonchalantly was, hey look, he’ll probably end up having a fire sale.

Now if it’s a business I think it is a fire sale tends to refer to, I guess, a business where we’re selling the assets that are effectively on the balance sheet. So the tangible assets, our plant and equipment is the fire sale that we tend to sell off. If he’s running a service, a business that’s primarily service based what are the assets he can fire sale? Yeah. In this particular case it’s pretty much stock that it’s already been paid for so it’s liquidating stock.

And if you want to liquidate most types of stock and you want to do it in a hurry and there’s a lot of it, and people know what you’re trying to do, the price you get tends to be less than you even paid for it. And things like the invisible, things like the intellectual property that could win in the business, all those off balance sheet assets that have real value to someone can’t be solved like that. They can’t be capitalised. Exactly. And to me that’s a crying shame, because the economy has changed its restructured over the last, I don’t know, 50 years or so.

We’ve moved from manufacturing and traditional types of businesses to where 70% or so of the economy is based on service type businesses. And if you’re running a service type business, some service businesses need some assets. I’m thinking of, I don’t know, a restaurant that’s going to have some tables and chairs and a kitchen and maybe a location, and they’ve got some equipment to sell. But 80 odd percent of the valuation of a business is tied up in the intangibles and you can’t just take them off and fire sale them, I guess. Look at a scratch, you might be able to sell off a client list if that was available in your industry, or if you’ve got some patents, you might be able to sell off some IP and licenses around there.

But just like any business that doesn’t plan when you’re in fire sale territory, there’s no way you’re going to exit on your terms. There’s no way you’re going to get the most of the value that’s there. And to me, that’s the tragedy. Yeah, I think what you’re heading towards in my mind here is really almost an introductory point around this, which is, why don’t business owners plan and prepare for sale? And I would contend properly planning to exit your business.

What one does with that business is sets about to tidy things up, enhance the profit, do things that protect the IP, make sure processes are in place, and things like that. And so the business is really running smoothly, so someone that comes in to buy it doesn’t try and knock you down on price. And the real value, both tangible and intangible, is blind in the obvious. And it’s a well run business. So if you don’t do that, if you don’t do that prepping to sell, you’re also not doing that preparation to carry on running the business.

So if you’re going to stay there for ten years, you should be doing that anyway, because it makes the business easier to run, easier for clients to understand, more profitable, all those things. And it so happens that if you run your business like that, it’s easier to package it up for sale and get the true value you deserve from it.

Yeah, I guess it’s the whole purpose of this episode, isn’t it? We’re saying, hey, look, if you don’t plan, you’re just running a risk. There’s all sorts of risks, and one of the risks is the only exit option that’s going to be left to you is that your business won’t be attractive when someone comes banging on the door. If they do, they’ll just see that it’s too risky to acquire and it’s too dependent on you, or it’s just not ready and they’ll just move on to something easier. So if you’re not ready, the risk is that you won’t exit your business and you’ll be left with a fire sale, which is cents in the dollar, pennies in the pound of what the business is worth.

So let’s flip that around. What we’re suggesting is, hey, look, we should be turning that right around and going, hey, look, even though I’m not ready to exit my business, I’m not even thinking about exiting my business in the two, three, five year time frame. For example, why should I be exiting my business now? What’s in it for me? What’s the upside?

The first thing for me, Kevin, is that the number of business owners that you talk to that go, hey, I want to sell my business for X dollars, X pounds, I’ve got this number in my head. But they’ve got no valuation. They’ve not had some sort of independent valuation to go, you know what? Your business is actually worth that to an outside buyer, because the market doesn’t care what the business is worth to you, what you think the business owes you. The market has methodologies and ways to value a business and assess the risk.

And it’s always a combination of your profit, your current profit, and there’s always a multiple to that profit. And that multiple is in simple terms, it’s a risk adjuster for the likelihood of that revenue continuing once the founders or the current owners custodians of the business leave. And the less risk to that ongoing revenue, the more likely that that ongoing revenue and profit is is going to increase, the higher that multiple will be, in crude terms. So that’s what we’re talking about here, isn’t it? Yes, absolutely.

And I think a consideration here is that if you start planning early to either just make your business a great place or with a view to exit it, people can start to realise as business owners, that they have a lot of choices they didn’t know existed. My example at the very front of this podcast was about a friend selling a business using an MLA man that walked through the door. Well, that’s one way to go. Of course it is. But how many people realise the number of choices there are a family sale, a self management team, employee ownership, lots of different things.

And you can grow it before you sell it. There’s all sorts of things you can do. The choices we could talk about for an entire program alone. But if people start early, they can start being intelligently, curious about it and thinking about, well, actually, what do I want to try and achieve out of the future? Do I still want to have a little bit of involvement in the business because I enjoy it, that’s why I started it in the first place?

Or do I want to just wash my hands of it all and go, but make sure I look after my close colleagues in the business that perhaps have been with me 2030 years? So perhaps I want to leave a legacy and allow that business to carry on in some way. You can’t make those decisions and get around to concluding that as a transaction in two, three months. You just can’t do it. And take employee share ownership as a topic that can take comfortably a year without rushing at it.

And we know people that have spent a couple of years plus prepping to do what actually is the best thing for their business and sell it to an employer employee, make it an employee owned business. You cannot do that. As I just said, if you start thinking about it three months beforehand. And the way you extract value depends on choose to extract value will depend on what your personal needs are as well. Do you seriously need one big lump sum?

Is that actually what you need? Or would you like a fair old lump of cash and perhaps an opportunity to carry on earning from that business? Those are great choices, but if people don’t sit down and consider them, and to consider them, you need to know what the business is looking like to a buyer. If you don’t sit down and consider those things, you’ll end up with less and less choices and someone else eventually will tell you what the decision is. And that could well just be the bank manager eventually.

Yeah. So what we’ve got to do is derisk it, and planning is de-risking it because we’re moving away from the hope model and the fantasy valuation model. We perhaps want to start by getting some sort of realistic third party valuation of what the business is worth today through a buyer’s lens and some sort of assessment and some sort of prediction based on what you’ve currently got in your business and understanding why the valuation is what it is today. So instead of just, here’s your valuation, if you understand what the valuation is today and what’s holding it back, if you’ve got time on your hands, then you can start to address those issues and close or improve the valuation, close the gap. If you’ve got some sort of aspirational number of what you want to exit for, for whatever reason there is behind that, you can see if this value potential in your business exists, is it going to close the gap to where you want to be?

Is the value potential greater than what you want or less than what You Want. And it’s probably handy to find that out earlier rather than later. If you know that the number, the aspirational number that you want, is somewhere far greater than the current value potential of your business, then you need to know now, when you’ve got some time to do something about it. I hear a lot of business owners say, hey, look, this is fantastic. Look, I am thinking about exiting my business one day, but I just need to grow it first.

And one of the things that is interesting, we go, well, okay. So if the valuation is based on the profit and a multiple, when you say grow the business, what is it you’re growing? And they tend to say, well, I just need to improve the profit, because I think that the multiple for my industry is x. And I go, okay. Are there any examples in your industry where the multiple was bigger than X?

And they go, yeah, well, there’s these sort of things that happen. And I go, what if you rethought about the growth of your business? I just want to grow my business first. And what if you rethought about that growth? And instead of thinking about revenue or profit growth, you thought of your business as an asset.

And you started thinking about asset value growth. Growth in the valuation of your business. So while you’re just growing your business before you’re getting it ready, before you’re getting ready for exit, you’re looking at the business as a whole rather than just half of the equation, which is just the profit side of things. Because if you do put things in place in your business and we touched on the intangible assets earlier, if you put things in your business that will increase the value of those intangible assets, bring those intangible assets to the front and highlight those intangible assets. Chances are it’s highly likely that you’re going to increase the M side of the equation as well as the profit, which will increase the overall valuation of your business, and that will accelerate your growth.

But working on the intangible assets often takes a year or two for them to come to the forefront and start to influence your valuation. You’ve actually touched on a thing. We hear a lot. I want to grow. I want to grow the business.

And it springs to mind, my mind of a business I worked with a while ago. And their single purpose was to have 25 million revenue and 5 million profit. That was it. That was at the point they wanted to exit. There was nothing about whether that was going to be sustainable or not, or whether it was ethical or anything.

It was just we’ll be 25 million with 5 million profit. And therefore there’ll be a multiplier. Blah, blah, blah. Now, when anyone looks at a business to buy and someone says, yeah, of course that business is going to be there next year. That’s where the in depth conversation starts.

What contracts have you got in place? How do you know the business is going to carry on? Because any of us can massage a business to dramatically increase the profit on a balance sheet by the end of a year. If we do it really expertly to absolutely maximise it to its absolute potential, the next day the business will be bust because we’ve soaked out all the costs on marketing. We’ve got rid of all of those.

We got right to the end. Bang right. We’ve achieved our 25 million revenue, 5 million profit tomorrow. There’s nothing in place to keep it going. We haven’t been renewing machinery, we haven’t been renewing contracts with our customers, et cetera, et cetera.

Sustainable business is what excites most people in the world of commerce. The purchaser of a business is going, how much effort am I going to have to put in to realise that profit I’m being told about? What’s the risk? Is it guaranteed or anything like that. The bank manager, the firm providing loans into business, they’re all looking exactly the same thing.

So our message here is very clear, isn’t it? That tidy these things up, increase that asset value of the business and you’ll be to exit on your terms in two, three years time or whenever you want to. But if you don’t want to exit, borrowing money becomes cheaper. Your customers love you more because you’re more likely to be there next year and the year after and the year after that. What’s the point of buying a product from a company and they give you a five year guarantee when you go to goss, I don’t think you’re going to be here next year.

People want longer term relationships with good value and that’s what preparing for exit as a side product delivers. Yeah, I think what you’re talking about is sustainable growth and sustainable future of the business. Because just if someone just sort of knocks the financials into shape, then they’re just not going to pass the first level of scrutiny. What we need to bring to the attention of business owners is for most business owners out there, the baby boomers. A lot of people have been working in their business for 10, 20, 30 years.

These are the people who are only going to sell their business once they got one business to sell and they want to get the most of that opportunity. What we need to bring to the front of their mind is that the people who are buying businesses such as this, this is not their first rodeo. They’ve bought businesses before so they know what they’re doing. They’re buying businesses. Whereas you’re selling your product or your service in your business and when you come to sell your business, your business is now the product and you only get to sell one of these products.

So if you just make your financials look pretty and you neglect, let’s say, the operating side of your business for several years so you can make the profit look better. Any buyer who’s bought a business before is going to start doing due diligence and they’ll uncover that real quick and they’re going to knock the valuation down and you’ll end up with, let’s call it less than the standard or the average multiplier for your businesses similar to yours with a bit of foresight. What we can do is, and this is why we’re saying, look, if we can spend two or three years working on this, we can bring the intangible assets to life and focus on them. We can talk about and bringing your process and your systemisation of your business to the forefront and become known for that which just improves the reliability. Get you on a succession plan without exit so that then the business has got some it’s got operational systems in place as well as management systems in place and the management systems report to the board or you as the owners of the business.

And all it’s doing is de, risking things for a potential acquirer. It’s making your business even more attractive to be acquired because they can see that it doesn’t require you to be there. As the business owner, you can still be involved and you can have the business exit ready and you can decide not to sell. But if it’s ready and you’ve got out of the day to day the operational side of things and all you’re working on is mentoring other people in the business, setting the overall strategy and managing the culture, focusing on those three things, then for you the business is a whole lot easier to run. And often when a business owner moves into those roles, those three key areas, what we see is that the stress that led them to wanting to build the business, to sell the business in the first place, because they were saying, hey, look, it’s just too much, I’ve had enough, I got to get out of here.

They’ve restructured it, they’ve taken the stress away, they become better leaders and inspirers in the business. We’ve got a functional management team that’s running the business. They’ve got a lot more career prospects and career options and they’re delighted so that it opens up the pathways for the rest of the employees in the business to start to see career opportunities. You touched on employee ownership before. So we get employee ownership in place.

And it doesn’t have to be the whole business. It can be just 20% 10% of the business. Have some sort of incentive for the employees in the business that gets everyone aligned for exactly the same outcomes rather than just sales or operations or one element of the business. We’re now starting to get the business where everything’s pointing in the same direction and it’s less dependent on the owners, it’s less risk for any new owners. It just becomes a really attractive proposition.

And the flip well, not the flip side. The additional benefit is that it’s just typically more profitable to run and it’s a really enjoyable business to be involved in. Yes, I think here is a good time to mention the human element of this lot in some respects. Some people might be listening to us and thinking, well, this is always kind of a bit of a process and I don’t really like that sort of thing. It’s my business, it’s my baby.

To kick off my thinking here, I would mention that in my colorful history in working in different industries, at one point I was in a publishing business, a big, big publisher in the UK. And I remember going to events and the author would come in and the author, just by the dint of their presence, the room would quiet down, there’d be some mutterings and everyone would look it’s the author. And this individual was inextricably bound with the status of being an author, which is some sort of demigod really. And that’s probably the first time I recognise this concept of identity for you. What on earth would happen to that person, that individual, that successful author, if all of a sudden they were just Joe Blogs or whatever their name might be, and not an author?

They’d feel naked. They’d feel like a failure compared to where they are now. And we work with people that have been enormously successful. They’ve put so much effort, professionalism and time and money and sacrifice things as well, getting their business to where it is that some of them have become pillars of a community, either geographic community or a business community. And they’re known for their success and they’re introduced by their success.

And I think a lot of we know a lot of people that we talk to. One of their reluctances to get planning to exit their business is that they’re recognised and they’re no longer going to have that apparent status of their role in industry or commerce. And I think putting it off, what that actually means is you just chuck yourself off a cliff at the end of it and there is no transition. One day you’re the successful owner, managed business that is taking things from nothing to a multimillion pound business and the next day you can’t even find someone to go Crown Green Bowling with. And I’m not having a go at Crown Green Bowling, by the way.

I’m sure it’s a lovely sport, but the change is so radical that some people mentally suffer if they haven’t prepared properly. In fact, many people do. So I think the things we’re talking about, about planning ahead, also looking to the future, past that moment when the transactions happen and one exits the business, then includes, well, what am I going to do? What am I going to do the morning after I sold my business? When I get up in the morning.

What’s the new identity I’m going to have? How do I want to be known? And that takes a bit of thinking about and often it benefits from external people challenging that and coming up with ideas. And people I do know that have done that have had very fruitful lives and effectively gone onto a new life and in a new business where the imperatives are different and it becomes more fun again. Yeah.

So what we’re saying is don’t underestimate the importance of, let’s call it personal exit planning, understanding what you’re going to do next because you’ve been wrapped up in being the owner of this business for so long, it becomes your identity. So what are you moving to? So we’re talking about business owners being quite visionary characters. They need a vision of what they’re going to move on to next and they need time to make this transition of, I guess, disassociating themselves with their business so that the business can go on and flourish without them. So there’s a part of that personal exit and I think it’s also we’re saying you really need a couple of years to plan the exit so that you can get to exit the way you want to exit.

Do it on your terms and get the business in shape so that you got some idea of what the future of the business will look like and you’ve got some influence as to how that will happen, which is about doing it on your terms. Which just reminds me Of A Stat, and I’m not sure if you shared this with me or it Came from One Of our M and A friends. The reality is that of all the businesses, the privately held businesses that are on the market or that go to market for an exit, only 20% end up with some sort of deal. 80% don’t even get to a deal because they’re just perceived to be too big a risk, not ready, not attractive to be acquired by people with the money ready to go. Now, of those 20%, half of them end up with some sort of earn out arrangement, which means that the buyer has made an offer.

They’re given an offer that they accept, but it requires them to be involved in the business, ensuring those future revenues and targets are achieved over the next two, three, maybe five years. So what that suggests to me is that business owner is they’ve taken the risk of building the business. They’ve spent 20 years consuming, taking on wearing all of that risk and building the business. And at the point of exit, they’re still taking a risk because they haven’t prepared it so that it’s attractive. So what we know is of those earn out arrangements, most of them fail.

More than 50% of those earn out relationships aren’t completed. And I’m just talking about where an earn out relationship where the rest of the money coming to the owners is dependent on their involvement and achieving results, rather than just some sort of deferred payments. Now, if we say that less than half of those earn out requirements are completed, that means that only 10%, one in ten of business owners that go to sell their business end up with a successful complete exit. That’s got to change. That’s got to change because there’s just so many people depending on making that happen.

So we’ve got to remove that risk, we’ve got to help them achieve that exit, because what should be a highlight of their career ends up feeling like a messy divorce. And that’s the risk if we don’t plan exactly. Let’s not talk about messy divorces. But that’s exactly what it ends up looking and feeling like. It was only two days ago, I was having coffee with a business friend and he was telling me about his exit from his business and his earn out ended up being zero through circumstances of COVID So he did get a cash lump, but COVID stopped it.

There’s all sorts of reasons why it won’t happen. I’ll tell you now, if I was selling a business and I wanted to turn someone over, I’d load it into earn outs and pretty much any earn out terms I could change so that they were never achieved. And I have a successful business to have the assets and you wouldn’t get your earn out. That’s so wrong. It’s so wrong.

And I suppose the thing in the UK at the moment is that it’s still a nascent industry, this concept of exiting businesses. And, yes, accountants provide services around these things, but they’re fairly limited in their range and they’re not particularly doing the advice piece. How do you protect your IP and recognise your IP, protect it, demonstrate it and have it as something that someone wants to buy? An accountant doesn’t generally look at that. They’re working on a balance sheet and a standard multiplier.

If the business was making a million profit on a five times multiplier, look how much it would change. If you increase the revenue by a bit, but the profit went up 10% and the multiplier went up another two times, that’s a fortune. That’s a lot of money. And that’s what people need to be looking at. They need to be understanding the mechanics of the deal and saying, how can I pull the levers so that my profit goes the right way, my multiplier goes the right way, I’m in control, and I can have a sweet exit where I’m happy and I’m looking after my industry colleagues, my people I’ve been working with.

And I can do what I choose to do afterwards, rather than helping someone turn me over on an earnings.

Yeah. So what you’re reminding me of there, Kevin, is that there’s a number of things that we need to do to get the business exit ready. We work to our we talked about IP and trademarks and protecting and process and being known for a process. We’re known for our process, not with the 21 Steps. And 21 steps are all the things that you need to consider and address for getting your business exit ready, identifying the value of your business.

And then you got to protect the value of the business, protect what you’ve already got. Because we haven’t even talked about unplanned exits yet. But we need to protect that to make sure things happen the way we want them to. We then want to have a look at how we can maximise the value and build on that foundation that we’ve got before we extract the value and then manage the value in a new structure. So what we can do is, instead of taking more time on the 21 Steps now, we’ll do a future episode on that.

But what we’ll do is in the show notes of this episode, we’ll just put a link there. If you want a copy of the 21 Steps, if you want to see what you need to be considering, what you want to address as a business owner, to start thinking about getting your business ready and all the topics you want to address, because buyers are looking at these things. We’ll put a copy of that in the show notes. That sounds excellent, Kevin.

I feel a blog post coming on here as well, summarising some of this. So we’ll do a blog post. We’ll put a link in the show notes, but I think we’ve covered we’ve covered a whole lot of things that we want to make sure that we just want to share with business owners of the importance of thinking early about this. Even if you don’t want to exit, if you’ve got no plans to exit, you want your business to be attractive, because then you can also take advantage of opportunities that you didn’t even see coming. If you’re on the front foot, you can respond to opportunities quickly, and then buyers won’t run away.

Sounds good to me. Hey, that’s probably all we got for today. Thanks for joining me, Kevin. Really appreciate you sharing your thoughts and your wisdom and experience. I’ll look forward to speaking with you in a month or so.

Absolutely. And how do you think the company uniforms working out?

The matching shirts? Well, you have to be watching this on YouTube to know what Kevin’s talking about there. Thank you. And I look forward to doing another one of these things.

About Kevin Harrington

Having worked in technology, telecoms, consumer electronics, payments, media and publishing, Kevin has enjoyed an interesting career history that embraces product and services businesses at all stages of their journey.

Before joining Succession Plus, he was CMO with the Panoply plc, a digitally native technology services company, founded in 2016, with the aim of identifying and acquiring best-of-breed specialist information technology and innovation consulting businesses. He joined the Panoply from Tungsten Network where he was Chief Commercial Officer.

Previous roles have included working with SMEs and large international businesses. Some highlights are Managing Director at the Emerging Payments Awards and the Prepaid Awards; Managing Director of Gx; Director of Sodexo Motivation Solutions; Global Marketing Director at BBC Worldwide; Product Group Marketing Manager with Sony UK.

His career started out in a completely different direction. His first two full-time roles were as a junior in an architect’s office and a civil engineering technician. Some of his drawings and designs were constructed and are still standing.