How much did your home increase in value last year?  Depending on where you live, it may have gone up by 5 – 10% or more.

How much did your stock portfolio increase over the last 12 months? By way of a benchmark, The Dow Jones Industrial Average has increased by around 13% in the last year. Did your portfolio do as well?

Now consider what portion of your wealth is tied to the stock or housing market and compare that to the equity you have tied up in your business. If you’re like most owners, the majority of your wealth is tied up in your company. Increasing the value of your largest asset can have a much faster impact on your overall financial picture than a bump in the stock market or the value of your home.

Many of you know that I have been part of Methods for Management for many years, both as a member and as the facilitator for the past 7 years. During the past 8 months, it has been my desire to expand the offerings of MFM into business coaching as well as the bureau format. As a result, MFM is now certified as a Value Builders coach and as a 5 Steps to Freedom coach. These platforms provide proven processes to address the 3 primary areas business owners deal with that of, Time, Team, and Money.

Let me introduce you to a statistically proven way to increase the value of your company by as much as 71%. Through an analysis of 6,955 businesses, it has been discovered that companies that achieve a Value Builder Score of 80+ out of a possible 100 receive offers to buy their business that are 71% higher than what the average company receives. This is calculated as a multiple of EBITAL or owner’s discretionary income.

How long would it take your stock portfolio or home to go up by 71%? Years – maybe even decades. This value growth is achieved by tracking the overall score on the eight key drivers of company value. Like a pilot working his instrument panel, you can quickly zero in on which of the eight drivers is dragging down your value the most and then take corrective action.

 These drivers of value include:

1. Financial Performance: your history of producing revenue and profit combined with the professionalism of your record keeping.
2.  Growth Potential: your likelihood to grow your business in the future and at what rate.
3. The Switzerland Structure: how dependent your business is on any one employee, customer or supplier.
4. The Valuation Teeter Totter: whether your business is a cash suck or a cash spigot. We all know what 2020 was.
5. The Hierarchy of Recurring Revenue: the proportion and quality of automatic, annuity-based revenue you collect each month.
6. The Monopoly Control: how well differentiated your business is from competitors in your industry.
7. Customer Satisfaction: the likelihood that your customers will re-purchase and also refer you. We have discussed Net Promoter Score previously as the best way to measure this driver.
8. Hub & Spoke: how your business would perform if you were unexpectedly unable to work for a period of three months. Remember “Fire Yourself”.

Let’s assume you’ve gone down the path to increase the value of your business, this creates the possibility of hitting your Freedom Point. What is this? Now what are your options?

When was the last time you calculated the percentage of your net worth tied to your company’s value?

When you started your business, its value was probably negligible. In many cases there may have been value, but zero equity based on how the business was purchased. In my case, both companies purchased were with none of my own money. Unless you purchased or inherited your company, it wasn’t worth much when you opened your doors, but over time, the proportion of your assets tied to your business may have crept up.

Let’s imagine a hypothetical business owner named Tim, who starts his company at age 30. He has a little bit of equity in his first home and a small retirement fund. When he starts or purchases his business, it’s worthless or has no equity, so it doesn’t yet factor into Tim’s net worth calculation.

By the age of 50, Tim has built up $600,000 worth of equity in his home, his retirement nest egg has grown to $400,000, and his business has blossomed and is now worth $4,000,000. Tim’s company has crept up to represent 80% of his net worth.

Tim knows the first rule of investing is to diversify, which he is careful to do with his retirement account. Still, he has failed to achieve overall diversity given the success of his business.

What’s more, he may have unknowingly passed something called “The Freedom Point,” which is when the net proceeds (i.e., after taxes and expenses) of selling his business would garner enough money for him to live comfortably for the rest of his life. Your lifestyle determines your Freedom Point, but when you pass it, it’s worth considering the risk you’re taking.

If this pandemic has taught us anything, it is that nothing is for sure, and a thriving business one day can turn into a struggling company overnight. When your business makes up most of your net worth and selling it would garner enough money to retire, there’s no financial reason to continue owning your business. You may enjoy the challenge, the social interactions, and the creative process of building a business, but keeping it may be unnecessarily risky.

When you’ve crested the Freedom Point and want to diversify—but still don’t want to retire—you have some options:

•  Sell a Minority Stake: In a minority recapitalization, you sell less than half of your shares. Often sold to a financial investor such as a private equity group, a minority recapitalization allows you to diversify your net worth while continuing to control your business.
• Sell a Majority Stake: In a majority recapitalization, you sell more than half of your shares to an investor who will most likely ask you to continue to run your business for many years to come. You get to diversify your wealth, keep some equity in your business for when the investor sells, and continue to run your company.
•  Earn-Out: When you sell your company, you’ll likely have to agree to a transition period of sorts. One of the most popular is called an earn-out, where you agree to continue to run your company as a division of your acquirer’s business for a specified period of time. Your earn-out may be as little as a year or as long as seven, but the average is three years. Therefore, if you’re past the Freedom Point and can see yourself wanting to step down in the next three to five years, an earn-out may be worth considering.
•  Transition Management Ownership: This is were the ownership is transitioned over a specific period of time to one or more senior employees as a way for you to realize the value you have built over time but to ”cash out” your equity over time. A close friend of mine through Methods for Management successfully did this about 5 years ago. When family does not want to continue the ownership within the family, this is a great option.

Building a successful business is rewarding, but when your personal balance sheet gets out of whack, it may be worth considering the risk you’re shouldering and the options you have for sharing some of it. Until next time, enjoy building value.