In this episode, we talk about the basics of business valuations with Jane Tereba of Capital Valuation Group. Learn about the two critical elements of every business valuation and how to proactively manage the value of your business. Jane and Bryan discuss how understanding the value of your business early can provide more opportunity to increase value when you’re ready to sell.
Podcast Transcript:
Announcer:
Welcome to the Sound of Automation, brought to you by Clayton & McKervey, CPAs for growth-driven businesses.
Denise Asker, Director of Mkt. & Practice Growth:
Welcome, Brian, from sunny Florida. How are you?
Bryan Powrozek, Sr. Manager Industrial Automation:
Oh, I was better last week when I was in Florida as well, Denise, but I’m back home in nice, cold Michigan. At least I missed the snow though.
Denise Asker:
Right. I’m looking at the snow behind you and it actually looks pretty nice, so-
Bryan Powrozek:
It does, it does. I can’t complain.
Denise Asker:
So last week you were at an industry conference, and I’m curious, maybe you can tell our listeners a little bit about what you… What the takeaways were there?
Bryan Powrozek:
Yeah. I was at the A3 Business Forum down in Orlando, and the biggest takeaway from talking to everyone down there, it was just… It was good to be in-person again, to be able to see people and talk. I mean, the content was fantastic. Lots of good input on where we see the year going, some of the developments in automation and things for business owners to look at, but for the most part, it’s those conversations that take place at the coffee break or at the networking reception that you miss, and you just really… Zoom is great, right? It’s a helpful tool, but it can’t replace those conversations that happen around the water cooler, so to speak. So that was the best part about getting down there and getting to see everyone again.
Denise Asker:
Good. I’m glad you had a chance to make it. So it sounds like today’s topic is on business valuations, and I know I have heard you talk about that with greater intensity over the last couple of years. Where are we at in the conversation and what are you hoping to learn today?
Bryan Powrozek:
Yeah. And I think the biggest thing I have found in speaking with business owners and potential clients and other industry professionals, it… A lot of what everyone has projected, right? That there is going to be the… All the boomers retiring, maybe retiring faster now as a result of the pandemic, not wanting to ride out another economic cycle. And so there is anticipated a lot of business transaction activity happening over the next, what do you call it, three, five years, whatever it might be, but it’s going to ramp up.
Bryan Powrozek:
And a key component of that, if you’re on either side, the buy side or the sell side, is understanding the value of what it is you’re trying to buy or sell. And so we have Jane Tereba joining us today from Capital Valuation Group, that that’s all they do is valuations. But really to talk about it more, not so much as kind of the end goal, right? That we’re doing a transaction so now we need to get a valuation done. It’s how does a business owner bring that forward in their process and use that valuation as a strategic tool, to decide do I need to make an acquisition to get to my target when I want to sell the business?
Bryan Powrozek:
A big conversation right now in professional services in general, definitely within the automation world as well, is some type of employee stock ownership, there is… It can take a number of different forms, but how do we try and… We can’t just continue to pay and pay and pay in terms of salary, so we have got to try and find other benefits to attract and retain talent, and employee stock ownership is just one of those. And so the valuation becomes a key component in figuring out what’s the right plan for you? Would this even work? Will that type of strategy help you in the long run? So we felt that getting someone on to talk about valuations, help trying to demystify it a little bit for business owners, would be important.
Denise Asker:
Sounds good. I look forward to meeting her and hearing the conversation.
Bryan Powrozek:
All right. Thanks, Denise.
Denise Asker:
All right. Talk soon.
Bryan Powrozek:
Hello, and welcome to the Sound of Automation Podcast. I am Bryan Powrozek with Clayton & McKervey, and joining to me is… Joining me today is Jane Tereba of Capital Valuation Group. Jane, how are you doing this morning?
Jane Tereba, Business Valuation Analyst:
I’m great. Thanks.
Bryan Powrozek:
Excellent. So maybe just to kind of start things off, and for listeners who might not be familiar with Capital Valuation Group, can you just give me a little bit of background about what you all do?
Jane Tereba:
Sure, sure. We’re a firm actually located in Madison, Wisconsin, we do… But we work with clients throughout the country. We have been doing business valuation and nothing but business valuation since 1974. And so what we love about that is that it gives us an ability to really be independent, so we don’t provide any other services aside from business valuation and damages support in litigation cases. But we don’t do any tax work, we don’t do any accounting work, so we have been primarily focused on business valuation for 47, almost 48 years.
Bryan Powrozek:
Obviously, you and I deal with it a lot in our respective roles, but for the business owner out there, a small to mid-sized business owner, I know they hear the term business valuation, particularly if they’re going through a sale or something like that, but can you maybe just give people a little bit of a background? What a business valuation is, how do you come up with it? Things like that.
Jane Tereba:
Sure. Business valuation really is all about two things. It’s about cash flow. So if you think of it from the buyer’s perspective, what is a buyer interested in? They’re interested in understanding what… How are they going to earn a return on an investment? So it’s the forecast of some kind of financial metric, usually cash flows, and then that also gets combined with the risk within the industry, within the economy, the size of the business, and a host of other things that help us understand what is the likelihood that those cash flows are going to play out in the future. So business valuation, at the base of it, really is about cash flow and risk.
Bryan Powrozek:
Excellent. And I think more often than not, and as we were kind of preparing for this episode, it seems like, in a way, business valuation is almost like insurance, right? You don’t think about it until you need it, and then at that point it’s almost too late, right? That often it’s those major business events. You’re looking to sell or you’re looking at an acquisition, things like that, that people start thinking about the business valuation. But in reality, it’s something that should come a lot earlier in the strategic planning for a business. So can you give a couple examples of how a business owner might use a valuation earlier on to help with their strategic plan?
Jane Tereba:
Sure. Well, the first thing I would just share is that business valuation and business value matters to any business, no matter what stage you’re in, whether you’re facing a transaction or just operating your business, because the same things that increase value make your business better. They make it a better place to work. They make it a better environment. So focusing on ways to increase the business value overall will just continue to improve not only the culture and… Or not only the financial, but also the culture.
Jane Tereba:
And I think what’s really important, particularly when we’re working with privately held businesses who aren’t focused on quarterly results and giving updates, and we as small businesses and privately held businesses have a longer-term outlook. Our strategic plans tend to be longer. That means that if you’re going to impact change on the business, it’s going to take time. So if you don’t understand what the value of your business is today, if it’s not the value that you want when you exit, if you do it early enough, if you understand it early enough, you can make those changes to affect some change and perhaps increase the value. So knowing early just gives you so much more time and so much more advantage to be able to increase the value, to be able to improve the culture.
Jane Tereba:
And we give this example a lot. I mean, you think about this. Likely, if you’re the investor, you’re the owner of a business, likely this is your retirement plan. We go along and we offer benefits to our employees all the time saying here is a 401k plan, here is some profit sharing, and you get those statements quarterly and you look at them and is the market up? And would you really never look at your 401k statement? But that’s what business owners essentially are doing by not understanding their business value.
Jane Tereba:
So periodically understanding what it is so that you know where you’re going, you can kind of take your worker hat off, if you will. You kind of, as an owner, have two hats. You’re the worker and you’re the investor. And if you can put that investor hat on and say, how do I track this investment and what do I do to manage it? And again, the sooner you can do that, the time on your side is always critical.
Bryan Powrozek:
Yeah. It’s interesting because we have heard this a lot, especially recently. I think as companies have gone through the pandemic and they’re… Maybe some business owners who are thinking about, well maybe I’ll stay around another five years or something like that, they’re all of the sudden starting to think, “Well maybe I don’t want to run that risk again. We made it through this one, I want to move ahead.” And so you start having those conversations and they say, “Well, I would like to sell.” “Okay, well what do you need to retire?” “I’m not really sure.”
Bryan Powrozek:
Or there is another one of my clients that we have been talking to that they have got an idea of what they want to do when they retire from the business, but they’re not sure what that bridge is. Can they get there just organically with growth? Do they need to make an acquisition? And so knowing kind of that stake in the ground of where you’re at today lets you then figure out your plans going forward. And, yeah. If you know that you’re going to need to make an acquisition, you start getting all of the things in order right now so that when… It’s kind of like buying a home, right? When the right opportunity pops up, you’re ready to move, so.
Jane Tereba:
Exactly, exactly. And it could be, maybe it’s investing in more capacity internally. Maybe it’s replacing some equipment, or there is a whole host of things that go into that risk factor that you can control. Are your customers diversified? Are your processes documented? How much leverage do you have? What is the age and condition of the assets that you have? Nobody wants to come in and buy run-down… To your example, your house example is perfect. You want it somewhat refreshed, so they know that they’re not coming in and buying a problem that they’re immediately going to have to address.
Jane Tereba:
Again, just the more time that you have, the more you can identify those things of where you might need to make additional investment and maybe it’s an acquisition or maybe it’s just sprucing up what you have already, and just making sure that everything is documented, that you have got a management team in place that’s not just reliant on the key business owner. We see that a lot where you have got the… Everything. There is just so much tribal knowledge that the owner has, or the founder, wherever you are in the life cycle of your business. But the more you can develop a really strong management team also works to increase value and culture as well.
Bryan Powrozek:
Yeah. And I like what you said there about the… A lot of the changes you would want to put in place to improve your value are changes that are just going to make it a better place to work regardless. It will improve employee morale, it will give the business owner a better ability to track their financial performance and understand how decisions made… Operational decisions made are impacting the P&L, and hopefully makes the business more profitable, which then drives the value up even more.
Jane Tereba:
Exactly. Exactly. Yeah. And I think, what you had mentioned too, a lot of people coming off of this pandemic are tired. They’re ready. They’re ready to be done. I think what we see sometimes is, we’ll send out a meeting… Calendar invite, invitation, and they’ll say, “Oh, don’t put the words valuation on it,” because they get scared that as soon as their employees find out that they’re going to get the business value, that everybody is going to assume there is a transaction.
Jane Tereba:
So even doing this more regularly for actually just… Putting that investor hat on and saying, “I want to manage my investment,” and communicate that maybe as transparently as you can with what information you’re comfortable sharing, just so that people are comfortable that you’re going to get this valued, but the reasons are because you want to work to… It’s not necessarily going to be a transaction. You’re managing your investment.
Jane Tereba:
And so I think some of the people kind of waiting for the last minute, I think has to do with fear and not wanting people to know or overreact that they’re going to get the business valued, and that means I have got to find a new job, so I think also just using that communication as… And shift the paradigm a little bit from this is a transaction to, “I am just managing the investment and trying to find ways to improve the business.” It’s just, it’s in the messaging as well.
Bryan Powrozek:
Yeah. It’s funny. I have caught myself doing that when I’m… If I’m sending an appointment out to a client that we’re meeting to talk about succession planning or something like that, being very conscious of the title of the meeting so that if somebody is stalking their calendar, they don’t start getting nervous that something is happening.
Jane Tereba:
We’re usually very careful too about when we’re teaching, just doing the titles of the courses that we’re putting out, because people are worried about that. If somebody sees them in something that is labeled the wrong thing, that they’ll-
Bryan Powrozek:
Exactly. Yeah. Employees start getting nervous and wondering what’s… And it’s funny. From an employee side, I mean, they’re all… They’re invested in the business too, right? And so when there is that uncertainty out there of if the owner is considering a sale, I mean, what does that mean for me as an employee?
Bryan Powrozek:
But then there is also, I mean, on the flip side, there is we talked a little bit, I think, in prep about the interest in employee stock ownership plans, right? Whether it’s an ESOP or some other type of plan like that, that helps provide incentive for the employee, but still to figure out if that’s the right path or if that’s going to get you where you want to be, you have got to start with the valuation to figure out where you’re at today.
Jane Tereba:
Exactly. Yep.
Bryan Powrozek:
So you had mentioned there are some things… You gave the example of kind of refreshing the business some. Maybe updating some of the assets, things like that. What are some other ways that a business owner can kind of proactively manage the value of their business?
Jane Tereba:
Yeah. So like I had mentioned before, business valuation is all about cash flow and risk. So first of all, when you get a business valuation, you’re going to work with an appraiser who is going to estimate what those future cash flows are. The better that you can be at forecasting yourself, the better history you have of forecasting, the more… The less risk there will be in that forecast, if you know what I mean. You’re experienced, you’re not just throwing a dart at a wall. You kind of know what you’re doing. You know what drives your business, you know what it takes to grow that… To make that growth, whether there is investment in people or infrastructure that needs to happen to meet those goals. So the more you can start doing your own internal budgeting so that you kind of get comfortable with how that process works, that will make any [inaudible 00:15:18]… Any projections that are included in a valuation much more meaningful.
Jane Tereba:
So that would be one piece of advice, is to just start budgeting, and… If you’re not already, and if it’s maybe one year, maybe it’s a three-year plan, and start to kind of look out a little bit farther on your own to see how accurate can you be in your forecasting? Because the more accurate you can be historically in your forecasting ability, the more reliable any other forecast would be, so that would be one thing.
Jane Tereba:
I had mentioned looking at the age and conditions of your assets, if there is going to be a risk that a new buyer is going to come in and have to make a big investment right away, that will work to depress the value. So making sure that you have got investment in capacity. Somebody wants to buy capacity. They don’t want to buy a plant. This is a bad example, because it’s a manufacturing example, but you don’t want to buy an [inaudible 00:16:08]… A plant that’s running at capacity. There is no room for growth without some significant investment, so that could work to… In negotiations against you, if you don’t have upgraded facilities.
Jane Tereba:
Dependence on key people is another one, like I had already mentioned, that we see a lot where all the institutional knowledge rests with the owner, so the more you can diversify, hire that kind of executive management-level team, that you can start to really… And not just in words, actually delegate to the management team, because it’s great to have a VP of sales, but if you don’t actually let them run as a VP of sales, then you basically just have a salesperson.
Bryan Powrozek:
Exactly.
Jane Tereba:
So making sure that that piece is together, and that also just again, that just works to improve the culture of the business. So even if it’s not intended to improve business value, the culture should improve as well. And we all know right now with how hard it is to retract… Or attract and retain employees, so the more you can give them some authority, I would think the better.
Jane Tereba:
And then another one that we see typically in our smaller customers is that they have some customer concentration. That’s not always something that’s an easy one to overcome, but the more… And those customer concentrations can be a double-edged sword. On one hand, they’re great because you tend to get recurring revenue from the same customer and it’s a good relationship, and so you can kind of count on them being there.
Jane Tereba:
But the risk of course, is what happens if all of the sudden something changes within that customer. They’re acquired, or the person that you have the relationship with leaves, or something goes sour and they represent a significant… And by significant, I mean 10% or more of your sales. If you have got that kind of a concentration with a number of clients, working to try to diversify that, and that is not an easy task. But that again is why you want to do this earlier so that you can kind of get a sense of where are the pressure points that you can really work on and make a change. Those are some of the factors that we see most commonly.
Bryan Powrozek:
And it’s interesting. I mean, we go back to the analogy of buying a house, and maybe it’s just top of mind, because I’m going through the process myself right now, but it’s… It really becomes that negotiation, right? And you have agreed on a price, and now we go in and get the inspection and say, “Oh, well, the furnace is going to have to be replaced in a couple years,” and this and that. It’s really trying to almost kind of turn it around as the business owner and say, “Hey. What are some of the things that I would take exception to if I were acquiring this business?” Right? The fact that you brought it up, and we see this a lot.
Bryan Powrozek:
I feel like there is in that maybe five to 10 million-dollar revenue range, businesses make this jump where they establish that team. The owner can get the business up so far just based on kind of carrying all the responsibility themselves. But at some point, if they want to grow past… I have seen it in that five to 10 million range, but if they want to grow past that, they have to really build a team around them and start relying on the expertise of the members of their organization, so I think that that’s… That, to me, is one thing I think a lot of business owners who are… Who want to try and use this as a tool should think about and then help address, like you said.
Bryan Powrozek:
If you have got a concentration of customers, that there is a risk that those could go away, then you want to make sure you’re protecting against that in the… Being in Metro Detroit, we have a lot of clients who work with the auto industry, right? And that is a notoriously difficult industry and it has its ups and downs, and so you always seem to hear that, “Oh, we want to diversify more out of automotive.” It’s like, “Okay, well, that’s going to be great for you. It’s going to be great for your business,” just now you actually have to do it as opposed to just having it on your to-do list every year.
Jane Tereba:
Value, when you mentioned the thing about the house again, you do get a valuation, and we’ll tell you the value of your business is $20 million. I’m making a number up. Then if you are going to actually transact, then you do go through a negotiation, and price doesn’t always equal the value, just like in a house situation. Now our housing market here around the Madison, Wisconsin area is very vibrant right now, and so houses are selling well over listed price, so before those valuations can kind of catch up. So I just wanted to throw that in there too, that whatever the value is that you would get from an appraiser might not always be what you transact at, but-
Bryan Powrozek:
Yup, exactly. And just sticking with that house theme again, so typically… I mean, I would say that most business owners don’t go through this process a lot, right? Maybe they sell a business once or they make an acquisition one or two times during the course of their ownership of the business. What kind of advice do you have for a business owner who is trying to find someone to help them with a valuation, since it’s not going to be something they are probably very familiar with?
Jane Tereba:
Sure. Yeah. I think there is a couple different ways to value a business. And although it is all about cash flow and risk, some appraisers will rely on only historical information, meaning they’ll go back to last year, the last three years, and calculate an average of the company’s performance. People sometimes tend to like that because it’s something that has already been achieved and they find more comfort in that, that it’s already… That there is historical results that support that, and then they’ll assume that they are making an assumption that the business will continue to perform that way forever.
Jane Tereba:
Now we know from working with closely-held businesses, that they’re very dynamic, and it isn’t always going to be that your results are going to be the exact as last year or even the average of the last three years. So my first advice is to have… To find somebody that’s going to be forward-looking. This is a little valuation techno talk, but we do what’s called a discounted cashflow method, and that means that we sit down with the business owner and we look forward and talk about and really understand the owner’s business plan. Do you need to hire somebody? Do you need to invest in something? Is an acquisition on the horizon? What is it about the future that’s going to look different than the past? Because a buyer buying the future, they’re not buying the past. They’re buying what the future ability of the firm is.
Jane Tereba:
So finding somebody that will… That you can trust, and of course that’s going to come with some rapport and some interviews and other ways that you find somebody that you can trust, but then somebody that will spend the time to really get into the details and understand and know your business so that you can build a good model that will provide a good value, either for planning purposes, for succession planning, for transaction, whatever it is, but really finding somebody that will take the time to understand the future business plan is really critical.
Bryan Powrozek:
Yeah. And I would really like to just underscore that that second point, having connected with Capital Valuation Group, through Control System Integrators Association, it’s so important for someone to understand your business, the industry it operates in. Because as you said, someone doing a valuation… Anybody who does valuations can come in and put a value on your business, but if they don’t understand those unique characteristics and thinking about integrators, they’re job-based, right? So you can have a really strong quarter and then the next quarter comes down and then it jumps back up.
Bryan Powrozek:
And so being able to understand that and talk to the business owner about how… Okay. How do we smooth that out in the financials and how do we account for that in your forecasting? Because if you walk into a potential buyer with those financials, it’s going to make them a little bit nervous seeing those kind of big swings, but if there is a way that we can smooth that out and make it a little more consistent, that just helps your case when you’re selling. And really, unless you know the industry, you know what the companies are going through, it’s really hard to kind of identify the things that will help do that.
Jane Tereba:
Yeah. You’re absolutely right.
Bryan Powrozek:
Excellent. Well, Jane, I really appreciate you coming on today. I think you gave some great insights for business owners on how they can use valuations, not just as a kind of end-of-their-involvement tool, but something strategically throughout the… Throughout their whole ownership. I guess if anyone listening to this wants to reach out, what’s the best way to get in touch with you?
Jane Tereba:
Well, you can look us up on our website, which is capvalgroup.com. You can look for me on LinkedIn, and it’s under Jane Tereba, and all of our contact information is on our website and within LinkedIn, so that would be a great start.
Bryan Powrozek:
Excellent. We’ll include all the contact information in the show notes as well, so anyone trying to get ahold of you will be able to find it there. Well, thanks, Jane. Thank you for coming on today, and I appreciate the time.
Jane Tereba:
Thanks, Brian.
Announcer:
Thank you for tuning in. Don’t forget to like us, subscribe, and share on social. To learn more about Clayton & McKervey, visit us at claytonmckervey.com. That’s C-L-A-Y-T-O-N-M-C-K-E-R-V-E-Y dot com. We thrive on finding the solutions for you.
