Southern New England is peppered with family businesses; many of them are multi-generational companies stretching into the third and fourth generation of family ownership.
Over the past 10 years, there has been a revolution where many of these companies aren’t being passed on to the next generation. Instead, they are being sold to larger competitors or professional investors.
Why? Chief among the reasons is the speed of change in the business community, making it more difficult for smaller, less-sophisticated companies to adapt and compete. Also, the access to capital and low cost of capital has made transactions easier to finance. And in many cases, the next generation is not interested in the family company. This makes the emotional choice of selling the company easier.
And now, after the challenges of the COVID-19 pandemic, selling the company has become a welcomed choice. However, there are many questions the owner needs to consider. Among them: What is the company worth? Will the employees be taken care of? Will I be able to live the life I want? And most pressing – where do I begin with all of this?
The business owner could begin by looking in many different places, but let’s skip the tedious analysis just for a moment. Let’s begin by taking a more fundamental approach so that there’s a true understanding of where the real “drivers of value” are. And this is a great place to start because with value, owners have the leverage to solve many, if not all, the questions they may have. And for many, value is not where they may think it is.
Traditionally, we might be inclined to look first at the balance sheet, particularly fixed assets. While this notion may have been true in earlier times, today it’s the intangible assets driving value and cash flow.
Christopher M. Snider of the Exit Planning Institute argues in his book “Walking to Destiny” that up to 80% of business value lies in intangible assets. These can be categorized into four areas: human capital, customer capital, structural capital and social capital. Collectively, Snider refers to these as the “4 C’s.”
Human capital is the intellectual talent that exists in the company. This is vital to understand and is atop the list for good reason. As Jim Collins points out in the book “Good to Great,” it is not only important to have smart, dedicated people, but it is also important that they are working efficiently and fluidly as a team. Human capital does not include the owner. Presumably, if a business is sold, the owner is not part of the deal.
Customer capital is the quality of the relationships with customers. This includes not only the length or the contractual obligations already in place but also how integral the company is to the customer. Consider a smartphone. It likely contains a user’s digital wallet, schedule, contact list and every photo taken in the past 10 years; it’s arguably that user’s most important possession. That builds loyalty.
Structural capital is the collection of written procedures, processes, patents, trade secrets and other knowledge that enables a company to perform at a high level.
Social capital is the way the “ecosystem” views the company. In other words, reputation. Of course, with the growth of social media, bad news spreads faster than ever before, and purchases often aren’t made by customers without checking online reviews first.
I find that business owners tend to spend an inordinate amount of time on issues such as inventory and real estate. Although these components are essential to the business, they are not what your buyer is interested in. Real estate can be bought or sold, and more inventory can be ordered. But creating a team of people and a process that serves a customer base that relies on a company provides an opportunity to create substantially more value and sustainable long-term cash flow. Focus on the “4 C’s” to drive value.
John C. Ayers is a financial adviser with the Global Wealth Management Division of Morgan Stanley in Providence.
