By Troy L. Harmon, CFA, CVA, Chief Investment Officer, Henssler Financial
What makes a person so integral to a business that life without them makes the value of the business fall? We often run into situations where a business owner will express to us their personal worth to their business in such a manner that it seems the business cannot run without their involvement. Everybody wants to be revered as being useful or even irreplaceable, but if this is truly the case, you may have created a problem for yourself.
Key person discounts are not uncommon in business valuations. An individual who brings in the bulk of revenue or one who is considered the innovation driver may truly be an integral part of a small business. However, if you are a business owner, you may want to consider your own situation and how this might negatively affect your future.
As years pass, most of us come to consider the next phase in life, retirement. A business owner has a particularly tough set of circumstances. Will they hand the business off to their children, the most commonly chosen option? Will they put their business up for sale? Something unthinkable to many who have put so much of their life into building their empire, however large or small. In either instance, if business owners make themselves the one and only go-to person, many of their clients find it difficult to separate their personal identity from the business. Furthermore, if the owner is also the top sales person, the business could become difficult to sell or require significant discounts from normal valuation methods. Without the ability to transfer ownership, many businesses just fade away.
One of the best ways to combat this scenario is to build a solid team of employees who can handle most, if not all of the many client requests your business may field on any given day. Taking a back seat might be difficult to some, but it will add value to your business in the long run. You might start by hiring an entry-level employee who is a quick learner. Passing your knowledge to a worthy apprentice can prove profitable, and many enjoy the opportunity to teach someone else their passion. Who knows, they might become the future owner.
Another consideration is to create operational processes and commit them to writing so others can be trusted to create a uniform outcome for the business. This is not only good practice to free the owner from daily chores, but it can also lead to replicating the process in other locations, thereby allowing the business to grow more quickly. It has often been said that a good manager will work themselves out of a job. In the case of business ownership, that is exactly what you should consider; ways to lessen your business’s reliance on you as a daily operator or salesperson.
We have seen key man discounts in valuation reports around 10%, some are justifiably higher. If you are looking for ways to add value to your business, think of making it easier for the business to operate without you as an integral employee. This may allow you the time to think of more ways to grow since you may more time on your hands and maybe less stress to go along with it.
If you have questions, contact the experts at Henssler Financial: