Gordon Davis, The Daily Record Newswire
What is a company worth? The simple answer is that it’s worth what someone is willing to pay. Think about it a different way: Why would anyone want to buy (or buy into) a certain company? Because it has value to the person or group.
Value is central in discussions about acquisitions or bringing in young owners. So, how does one determine that value? Most firms have a buy and sell agreement that allows an owner to calculate a value. Or many good consultants can help an owner “value its firm.”
Several formulas can be used in the do-it-yourself approach, with most presenting different ways of looking at income potential. But income alone may not be the only reason someone would have an interest in buying or buying into a company. Young managers may want to have more influence or a chance at better compensation. Firms seeking to acquire may want to get into a new market or add new skills and experience to their existing practice. They may want a firm’s key people or access to long-standing clients. None of these reasons are necessarily satisfied by a formula.
I was working with an engineering firm some years ago. The founding principal owned 100 percent of the firm, but had decided to begin to broaden ownership.
We defined some ownership principles that would guide this new ownership structure, and one was that “ownership is not a means to create personal wealth.” For him, ownership was a means to shape the direction of the firm and thereby create an environment in which more people could influence those decisions and where everyone in the firm could achieve meaningful personal and professional growth. It was not that people would not be well compensated nor that ownership would not also have the potential for greater financial rewards. It was just that creating personal wealth was not the driving force in making business decisions in the firm.
When we rolled out this new ownership program to the firm, you can imagine that this particular principle garnered many reactions. One young engineer scoffed at the idea. He could not imagine why, in the face of many investment choices, anyone would want to invest their money in the firm if they couldn’t expect a good return.
All of this was a discussion of value, and for this owner, the value of the firm was not just in its ability to generate income and profits. It was also the ability of the firm to be a tool to create strong leaders, effective managers and top quality professionals who could be significant forces in their profession and their market.
This is a very successful firm. It has had steady revenue growth and good profits, but probably no better than most successful engineering firms. However, it is a magnet for attracting the most highly qualified talent, whether just out of school or more senior in their profession. The value of this firm is certainly in its financial success, but even more so in its culture. How does one value that, and is anyone willing to pay more for it?
I worked with another firm where the founding principals were looking for their exit strategy, and entertained two different acquisition proposals over a period of three years. In each, the value of the proposed acquisition to the owners was several million dollars; however, each acquisition failed, not for the financial value of the deal but because of issues of culture or a mismatched salary structure.
After these lengthy, difficult and emotionally draining efforts, the principals went to six young professionals in the firm and offered ownership to them. That eventually resulted in an acquisition value at 30 percent of what might have occurred if either of the original acquisition proposals had been finalized.
So, when thinking about the value of a firm, remember that its value is only what a buyer is willing or able to pay. Certainly it’s desirable to calculate an actual dollar value, which will undoubtedly include some intangible factors beyond income and profit potential. But a set value only means that a point of departure exists for a discussion with a potential buyer.
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Gordon Davis, a partner in the Succession Consulting Group, for 40 years has provided strategic counsel to firms on ownership, leadership, management and transition. Contact him at gordon@gordondavis.net.
