As a business owner, you’re often so involved with day-to-day dilemmas that you lose sight of why you’re in business, or you lose sight of your business’s potential. Usually, when you lose objectivity, you forget to think ahead. You worry about making money now rather than saving money for your future. You want your business to be profitable, but you don’t know how to properly invest the profits. Inevitably, small business owners become so focused on making a profit that they forsake other areas of their businesses and their personal lives. They think they have to choose value versus profitability. However, by growing a company’s overall value, small business owners can increase their company’s profitability and their personal sustainability.
00:33 – Value and Profitability are two separate things
03:38 – U.S. Market Segments
06:42 – Actual Business Sales
10:58 – 5x EBITDA?
13:15 – Size Matters
15:03 – Multiples Matter
16:55 – A Tale of Two Companies
20:16 – Focusing on Quality rather than Quantity
20:55 – Conclusion
Shortly after I earned my Certified Exit Planning Advisor (CEPA®) designation, a lifelong friend of mine reached out to me for help. In this article, I’ll call him “Jeff.” So Jeff called me and asked me to help him plan his personal finances. Ultimately, he wanted me to help position him to sell his business. Now, Jeff is what you’d consider a successful entrepreneur. He had new cars, a new house, a fancy boat, multiple employees, and money for travel. Jeff had spent his entire business career making his company profitable, and he’d done a good job of it. He’d worked countless hours, seldom taken vacation time, and hadn’t yet used his fancy boat.
For all intents and purposes, Jeff was successful. However, he had a problem – most of Jeff’s personal net worth was tied up in his business. He had reinvested most of his profits from his business back into equipment or other items he needed to turn higher profits. It was a vicious cycle. Jeff could tell me unique stories about each piece of equipment he’d purchased over the years, but his actual business wasn’t worth anything. Yes, Jeff produced a nice income for his own current consumption, but he didn’t have a business worth buying or retirement funds to sustain him in the future.
The problem was, Jeff’s “retirement ticket” was his business. Rather than investing money into retirement accounts over the years, Jeff had invested his extra money back into equipment for his business. Now, the only thing he could sell was his equipment, and that would only make him pennies on his dollar. He was stuck, and he reached the place many seasoned business owners reach. He realized that profitability did not equal value. Even though he had a profitable business, the business wasn’t an asset of value that someone would want to buy or into which someone would want to invest. While his business was profitable, it was not valuable. Although his business provided for his present, it didn’t secure his future.
Having a profitable business is important to your company’s survival and its attractiveness to investors and buyers. However, if profits are the only thing you’re seeking to improve, then other areas of your business will suffer. In an attempt to save money, you may hire employees with average skills so you don’t have to pay higher salaries for employees with exceptional skills. In an attempt to keep your profit margins high, you may keep outdated equipment and antiquated technological systems in place that hamper your operations instead of investing in state-of-the-art equipment and technologies. Although you’re keeping your expenses low and your income high, you’re neglecting other fundamental areas of your business.
Let’s look further into the difference between profitability and value by examining two different companies.
Company A and Company B have the exact same key components. They’ve both been open 20 years in the same industry. Each is producing $5 million in sales and has $500,000 in EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). They’re both experiencing the same nominal market growth. Therefore, from a simplified business standpoint, the companies seem to have the same value. However, they don’t.
We need to look further into Company A and Company B to understand why they don’t have the same value. Let’s look at their differences.
-Now, seeing this side-by-side comparison, which company is more valuable? Sure, the companies have the same sales and revenue, but which company would you pay for? Would you pay for the one that has no product development, worn-out equipment, no strategic planning, old systems, unreliable financial reporting, and little employee training? OR, would you be willing to pay for the one that has robust R&D, pristine equipment, highly developed strategic planning, state-of-the-art systems, disciplined financials, and an expertly trained team? That’s a no-brainer, right?
Instead of building companies that are valuable like Company B, small business owners tend to chase profits like Company A. You try to drive up revenue and bottom-line profits, the quantitative. Now, before you misunderstand me, please know that I’m not telling you to ignore profits. What I’m saying is that chasing quantitative results alone can negatively impact your organization. Yet, because you need the revenue, you often focus on quantitative results. However, if you want your company to be profitable for you AND valuable to others, you need to focus on your company’s qualitative differences. If you focus on driving the value – the qualitative – up, then profitability – the quantitative – should follow. And maybe, just maybe, you could see unimaginable increased profits and position your business to make it a publicly traded company or to sell it for profit in the future.
So, friends, value and profitability are two different things. Don’t be like Jeff who spent his whole life trying to drive up profits but never added value to his business. Additionally, don’t be like other business owners I see who drive-up profits but don’t save any money outside of their businesses. You may not want to sell your company, or you may not have a company that will sell. That’s fine. We can deal with that. Nonetheless, you can position your company in such a way that you are financially independent from it personally. You can increase its value and profitability to save money for your future retirement.
You won’t want to miss my next article where I’ll be discussing the types of value in business and which you need to be concentrating on!