Five Steps for Business Owners to Practice Good Corporate Governance

My favorite (and oftentimes most successful) clients don’t just ask me “how much is my business worth?” Instead, they ask, “how can I make my business worth more?”

They already know the obvious answers like growing revenue and cash flow. So my advice focuses on improving the marketability of the business through good corporate governance. By this I mean strategically investing in operations to make the business more attractive to a potential buyer.

Usually, my first step is to explain the benefits of good corporate governance and the risks of bad corporate governance. I have written before about how good corporate governance increases the value of your business and how bad corporate governance makes ownership transitions unnecessarily painful. Companies with outside investors or independent boards generally don’t have issues with this, but the vast majority of US businesses are very closely held, sometimes with a single owner or family group.

Once my clients understand the benefits of good corporate governance, their next question is, “what is the next best step?” While the answer to this question is different for every business there are some basic principles every business owner should know.

Do I need to do this right away?

If there is any likelihood of a change in equity or debt capitalization (a balance sheet event), there is no time to waste in implementing good corporate governance. Some examples of balance sheet events include:

1. Expected sale of the business in the next 5 years

2. Plans to issue equity to key employees

3. Redemption of minority equity investors

4. Buy/Sell events, where partners can buy in or cash out their equity

P.S. Even if you are a 30-year-old sole-owner with no intention to sell for the next 30+ years, a basic corporate governance routine is smart. You never know when something happy (a strategic buyer willing to pay 20x EBITDA appears!) or sad (you get hit by a bus and your spouse is suddenly running the company!) will happen that requires complete and well-organized corporate records.

Five steps for business owners to practice good corporate governance

Step 1: Hire a qualified outside expert or form an outside board

With an outside professional, you will get an objective perspective on your company and a high-quality road map to improve business value. Often, a valuation professional is your best option since we have a lot of experience taking a holistic view of a company including analyzing complex corporate formation documents, financial statements, and projections. Think of using a valuation specialist as a long-term partner rather than a one-time transaction. The benefits of maintaining a relationship include favorable fees for valuation updates, as the appraiser will gain efficiency by learning the nuances of your business and maintaining a detailed historical file. The best appraisers want to be part of the company’s journey over time. If it makes sense, and you have a good network of trusted advisors, an outside board is a great idea, if only to keep you accountable to the road map.

Step 2: Check in regularly

Establish a cadence that makes sense for your business’ strategic goals and ownership group’s needs. A rule-of-thumb is performing a comprehensive business assessment, including a valuation once every 3 years, but common signals that you need a new valuation include changes in capitalization, new industry trends, or the gain or loss of key customers or corporate leadership.

Step 3: Stay organized

Maintain a file of your key corporate records: operating agreements or articles of incorporation, detailed cap tables, tax returns, financial statements, corporate bylaws, annual budgets, etc. Then invest time to review and update them as necessary, but at least annually. These “form”  documents are often misunderstood, yet losing track of the documents can prove to be very costly. Keep in mind what would happen if you get hit by a bus. These documents should be secured in a data room as well as in hard copy, and accessible by at least one other trusted executive or perhaps attorney or advisor.

Step 4: Get stakeholders bought into the valuation process

In order to make smart decisions as a team, your corporate ownership and leadership needs to agree on the direction of the business. A comprehensive valuation is a great way to kick off conversations. Choose a valuation professional who can not only perform an analysis, but also facilitate a rigorous discussion about the relative merits and likely impacts of changes to the business strategy. The end result of a valuation process should be that all key stakeholders understand the supporting rationale for the present valuation and understand the factors that could create higher future valuations.

Step 5: Take action

A quality valuation serves as a report card for your company. Seize the opportunity to increase the value of your company by addressing problem areas or attractive opportunities to raise value. Maybe your revenue over-relies on one customer, or your debt capacity is underutilized. The valuation will quantify how much you would give up in a sale for making these operating decisions. Use that information to reconsider how you manage your business and make changes that will put more money in your pocket.

Need help brushing up your corporate governance? Let’s talk!

Liza Bowersox

Founder and Managing Director

(804) 482-0689

liza@artemisvaluation.com

Increase the Value of Your Business

Corporate governance has all the benefits of personal hygiene: it keeps your business healthy and makes it more attractive. And if you don’t keep up regularly, your business will end up looking shabby.

The concept of corporate governance refers to high level “outside of day-to-day” strategic investments to ensure the good health of a business. Ongoing business maintenance is important whether or not the business has outside investors or is preparing for a sale. A presentable business meets certain standards including:

• Current and accessible corporate formation documents

• Comprehensive and clean financial and tax reporting

• A robust balance sheet

• A well-considered financial forecast

• Comprehensive risk management

These are the sorts of things that companies with outside boards maintain and communicate at least annually.

Just like personal hygiene, corporate hygiene requires small, regular investments. The best way to prevent a cavity is to floss every day for 30 seconds. But like the patient who waits to begin a furious flossing regimen until the week before their dentist appointment, many owners wait until they need to or want to sell the business before making the business presentable.

For companies without outside boards or investors, one of the easiest ways to approach corporate governance is to commission an independent valuation of your business every two-to-four years. If done regularly and intentionally, the valuation process can be a catalyst to find and resolve problems. Minor, painless adjustments can create better cash flow while you own your business and a higher multiple when you sell. 

Outside business valuation is key to good corporate governance

A sound business will not only create annual earnings for shareholders, but also create long-term capital gains as the value of the business grows. Most owners are curious about the value of their ownership stake, and likely have some expectation of monetizing or transferring their ownership at some point. In my experience as a valuation expert, here are the benefits owners enjoy when their company commissions an independent valuation every two-to-four years.

1. Create consensus: a quality valuation will either confirm instincts regarding business value or illuminate blind spots. If the latter occurs, the valuation will quantify weaknesses. The owners can get ahead of conflicts arising from unmet expectations. Bickering ownership groups make unforced errors. Conversely, owners with aligned expectations for expected cash flow and potential sale value will make smarter decisions about reinvesting in the business vs. harvesting profit.

2. Identify opportunities: A valuation expert will conduct a comprehensive financial analysis to assess the quality of earnings. This analysis often results in a list of options to make your business worth more. It will point out unusual expenses (like corporate jet skis) and non-market compensation (anyone making too much or too little). It will also evaluate credit and operating ratios to determine the overall health and stability of the business. Making conscious operating decisions increases both the odds of attractive cash flow for yourself and the business’ attractiveness to a potential buyer.

3. Identify risks: a valuation produces an independent analysis of the risks to your business that hurt value. Once you understand these risks—like over-reliance on either a concentrated customer base or key employees—you can take steps to address and improve business value. These changes often have the added benefit of making your business easier to run while you own it. 

4. Control your destiny: a quality valuation forces owners to look beyond what is in front of them. To do the exercise well, you must project cash flow 3-5 years out and think hard about where you are steering your business. This exercise reveals which variables have the most influence on the money in your pocket and the value of your business. 

5. Out position the competition: a valuation includes an unbiased, third-party perspective on how your business stacks up to the competition in the eyes of a buyer. The best valuation experts can access benchmarking data beyond what is publicly available. Savvy business owners can use this information to outmaneuver the competition so that they are the most attractive option to a strategic buyer willing to pay top dollar for top quality.

6. Avoid unnecessary pain: lack of consensus among owners on the value of a business increases the odds of a pain when one or more owners wants to or needs to exit. And in the world of business transactions, pain is measured in dollars. In my experience, a contested transaction requires multiple appraisers ($50K+) and hordes of lawyers (another $50K+). Contested processes often result in wide variations between valuation positions, and strained relationships.

Sound corporate governance does not happen overnight! But owners who make a modest, regular investment of time and money can expect a more profitable, manageable business.

Do you need a plan to improve your corporate hygiene? Let’s talk!

Liza Bowersox

Founder and Managing Director

(804) 482-0689

liza@artemisvaluation.com

Behold, the Pain of a Breakup

Business breakups can be just as messy and dramatic as romantic splits. Taylor Swift, the queen of breakup songs, mines her soured business relationships for material just as readily as she does her long list of ex-lovers.

In this case, “breakup” means the end of a business partnership where at least one partner wants to be bought out.

A common (but avoidable!) breakup complication is how to value the stake of a departing owner. If the partners do not have a clear, and mutually agreeable plan for how to value the company, then determining a partner’s buyout price will be both a protracted negotiation and a profitable opportunity for the lawyers involved (yes, there will definitely be lawyers involved!).

How ambiguous valuation policies lead to bad blood

Imagine the following scenario. A family has owned a local sports bar for decades. Mom and Dad don’t want to grow the business but do enjoy the reliable cash flow and ample time at the country club. Their daughter, however, has ambition. She wants to cash out her 20% ownership so she can start and control her own new venture. Mom and Dad are not ready to sell the entire restaurant, so they agree to buy out their daughter’s stake.

How much is the daughter’s 20% worth? There are three viable options to find an answer, but if the family does not agree on which to choose, they are at risk of a painful (and expensive!) breakup. 

Option 1: valuation from the perspective of a financial buyer

This option assumes that a financial buyer plans to run a business the same way as the current ownership, using the same assets. This hypothetical buyer values the business based on historical cash flow and current industry multiples.

This valuation approach may make sense to Mom and Dad, but daughter may resist this method because she knows it will value the business at less than its real potential. She knows Mom and Dad have not invested in the business in years; and that a fully-engaged operator could take it to a new level. She doesn’t want a discounted valuation just because her parents are checked out. 

Option 2: valuation from the perspective of a minority owner

 Investors require discounts to buy a minority position in a company to reflect the fact that they can’t compel the controlling owners to maximize the company’s potential or pay maximum cash flow distributions. They will look at how much cash their stake produces annually and how much they expect it to gain in value over time. But they may pay 25-45% less than a financial buyer to account for their lack of operational control. Less control means more risk.

This valuation method should be the daughter’s least favorite. But Mom and Dad can plausibly argue that this type of buyer is their daughter’s only real alternative to their buyout offer, therefore this perspective should determine the valuation.

Option 3: valuation from the perspective of a strategic buyer

Strategic buyers pay more for a business because they can increase its value through special marketing capabilities, better access to capital, and/or synergies with their existing business.

If a local sports legend recently started a restaurant group and is paying extra to buy up other established sports bars in the area, the daughter should push to value the business like a strategic buyer would. She can argue that there’s a viable opportunity to sell the business at a premium, and she doesn’t want to miss out on that payday just because her parents are not ready to sell.

As you can see, there are many sides to this coin, and if the daughter and parents can’t agree on a method, a protracted and potentially relationship-damaging negotiation could follow.

Don’t leave a blank space on your operating agreement

The good news is that there are steps you can take to make a business breakup less tortuous than the scenario outlined above! It all comes down to practicing good valuation hygiene.

 Good valuation hygiene means defining in your operating agreement how you will value the business in case of a breakup. Often, partners leave this part of the agreement vague and promise to figure it out when the event happens because they do not know how a venture will go. While partners recognize ambiguity leaves them more options, they frequently ignore the added risks of bitterness and legal fees, as demonstrated in our example above.

Great valuation hygiene means regularly valuing your company every two years or so. A qualified valuation professional will lay out a framework for what your company is worth, which forces partners to confront how the business is performing and the ownership team’s goals for the future. A regular cadence of valuation updates can be accomplished at a modest fee level, and most importantly will protect ownership team relationships and ensure the business carries the right level of insurance in the event of an owner’s death.

Waiting until a breakup to launch a valuation process could result in upwards of $100K in valuation costs, plus legal fees. Taylor Swift reportedly spent $1 million to produce the “Bad Blood” video. While most people wouldn’t go that far, the potential cost of a damaged relationship shouldn’t be underestimated.

Afraid of a bad breakup? Want to avoid the pain? Let’s talk.

Liza Bowersox

Founder and Managing Director (804) 482-0689

liza@artemisvaluation.com

Valuation is More Than Just a Multiple

One of the biggest mistakes business owners make when valuing their business is to rely only on industry multiples. Since our job at Artemis is to provide objective valuations for companies, I want to break down which factors influence a company’s valuation, as well as what business owners can do to increase the sale price of their business.

What influences a valuation? Risk, reward, and market dynamics

It is true that the value of your business is heavily influenced by how the market prices other companies in your industry. But industry multiples come in ranges for two big reasons. The first reason is that not every company is the same; some businesses command higher valuations because of more growth potential or less risk. The second reason is that multiples are a reflection of subjective, time-bound variables. You may be exiting at a time when the market has an unusually rosy or gloomy view of your industry, or you may have a buyer with a strategic incentive to pay more.

For example, let’s look at veterinary hospitals, an industry where many owners are borrowing big to expand their businesses. This dynamic has the potential to add fuel to any valuation debate.

According to The Business Reference Guide (the good starting point to check out perceived “rules of thumb”), vet hospitals sell for 3-5 times EBITDA. If you want to sell a vet business with $1 million EBITDA, the difference between a $3 million and $5 million valuation means a 66% increase in your exit price. That’s $2 million extra dollars in your pocket!

The valuation of a growing vet hospital could be influenced by the stability of annual profit, or how well their leadership team has evolved to manage new lines of business. The sale price could also be influenced by whether the market believes the recent increase in demand was a pandemic aberration or a long-term trend.

3 things owners can do to increase the value of their business

Multiples will change over time, at the whim of market forces beyond an owner’s control. But if you want to sell your business (or just want to be ready for the moment when someone will pay above market prices) here are the top three things owners can do to command a higher multiple.

1. Create a succession plan: buyers hate key person risk. If you want to sell your business and ride into the sunset, you need to prove that you have a turnkey operation that can operate without you. Make sure all customer- and vendor-facing roles are staffed by your management team. 

2. Improve the quality of your revenue: buyers fear a situation where revenue drops after you sell. They want proof that your customer base has low churn and recurring revenue. If your business doesn’t have those dynamics, you should at least show that your marketing program provides stable and predictable revenue.

3. Identify strategic buyers: great entrepreneurs transition from selling their product to selling their business. Think about who has the capability to transform your business; those buyers will pay irrationally high prices. The classic example is Disney paying $4 billion for Lucasfilm because they were able to leverage the Star Wars brand across their film franchises, streaming service, theme parks, and more.

Need advice on how much your company is worth? Or insight on how you can increase its valuation? Let’s talk!

Liza Bowersox, Founder and Managing Director

(804) 482-0689 - liza@artemisvaluation.com