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« When doing more of the same doesn't work | Main | The fully functional business »
Tuesday
Jan152013

What really drives asset value?

For most of us our greatest asset - and the source of our future wealth and freedom - is our business. And what drives the valuation of that asset can be simplified to a formula: V = P x M, or in other words, the value of our business is a function of the profit we generate (the P) times a multiple (the M). So far, so obvious.

So, who controls our profit? Well, obviously, we do - and most business owners spend huge amounts of energy on driving this number.

And who controls the multiple? Not quite so obvious. However, our view is that we do too - or at least we do if we really understand what drives that multiple. But too few business owners focus energy on this side of the equation; which is a pity, because that is where the real power is, particularly in a recovery phase. And it's where most of the fun in running a business lies.

To explain this I'll use a framework that we call the Seven Layers of Valuation. Each layer contains the critical assets that build business valuation. And each Layer you put in place increases the worth of your business by a particular increase in the multiple. For the sake of simplicity in this explanation I have taken these numbers out, but if you would like to talk these numbers through for your business please drop us a line.

It's important to note that each Layer is cumulative. That is, you can have elements of each Layer in your business but you cannot achieve the full impact until you have fully implemented all the Layers below.

 

 

 

 

 

 

 

 

 

The first layer is simply the industry benchmark. That is, your business has all the characteristics expected of a typical business in your industry. To achieve that Layer you will be able to demonstrate good control of your costs, stable and sustainable revenues, and no surprises on your balance sheet (assets and liabilities). Your management team will also be up to scratch. If you have weaknesses in any of these areas the multiple your business can command will fall below the benchmark; your business will be devalued, perhaps significantly, by any external valuer. It really is critical for the future value of your business wealth that you get these areas sorted out pretty quickly. If you have concerns and would like some advice, once again, please get in touch with us.

Assuming you have achieved a benchmark business, how do you strategically build your asset value? How do you increase your multiple?

Your first area of focus should be on your team; on the talents, capabilities and culture of your business. Assets can be commercial and cultural and this Layer is all about culture and is the absolute bedrock that supports everything above it. A fully implemented talent and culture strategy will create a business already worth more than a typical benchmark business; a "V + 2" business. That is because with talented people, committed to your vision and enthusiastic to perform, you can innovate and extend your assets. Without it you will struggle to build real value and you will likely be stuck in a business dependent on you to operate it when you could be innovating and growing it.

With a talented team that are functionally efficient and independent of you, you and your senior team can innovate systems and products. And these innovations can be fully leveraged. This is a "V + 3" business and, as the economy begins to grow and new markets develop, it is the ability to innovate which begins to create real value hence the higher multiples achieved.

The next Layers take us into truly valuable businesses. These are enterprises that fundamentaly understand their core DNA, the rocket-fuel of the business; what we call their "intellectual property". And they know how to use it to build radically new product opportunities ("V + 4"), new channels ("V + 5") and can build and exploit powerful brands ("V + 6"). These are the truly valuable businesses of the future and the ones that command the highest multiples and, if they wish, can achieve truly significant Scale ("V + 7").

To find out more about IP and how it is the core asset in your business, read Darren's article "How do you choose which business model will work for your business?".

And to find out more about building Layer 1 in your asset story, make sure you're subscribed to our Love Business newsletter to receive our Culture, Talent and Capability edition next month.

 

 

Take Stages test: burst through your brick walls

 

There are 14 key stages that each business needs to go through to get to advanced, sustainable growth - including two brick walls which many companies never break through.

Find out where you are in the lifecycle - and what to do next. Complete stages and download your 15-page action plan.

Take the Stages test

 

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