The EV Formula

Wouldn’t it be great if there was a simple formula that codified the development of enterprise value for privately owned businesses?

Well, here it is, The EV Formula…

V is for Viability

It should go without saying that any business must be viable to survive. By ‘business’ I mean a person or group of people who have come together to solve a problem for another person (hopefully a group of people) and in solving said problem, benefit from an exchange of consideration, ideally money. By ‘viable’ I mean it costs a dollar to buy or produce and you sell it for two, with running costs less than the difference, so you make a profit.

This is an obvious area of focus when starting a business, particularly if you’re asking a third-party to invest in your idea, but once up and running, there are times when the viability of the business can be threatened, and owners are frequently unaware of this risk, until it’s too late. Keep working to understand how you add value for clients and customers, how substitutes can be just as dangerous as direct competition and remember these insights when tinkering with your business and particularly your proposition (ie product or service).

Ask yourself; how could this decision effect the viability of the business?

C is for Capability

Assuming you have a viable going concern, the next part of the formula is ‘capability’. By this I mean every single client or customer of the business, receives a consistent experience, in line with their expectations. Crucially, this must include every member of the team, playing their part, without your direct input, so if you’re jumping in and firefighting frequently, you’re not quite there yet.

To engineer this scenario, one needs to learn to delegate effectively, which means accepting one’s weaknesses, hiring good people and building a well-balanced team, with strength and depth across the firm. To do this, map out every process it takes to manufacture and deliver your proposition. Then group tasks into both roles and processes. That should give everyone a clear track to run on and a great foundation for accountability.

Ask yourself; does this decision improve the capability of the business?

Viability and Capability appear in parenthesis in the formula, as they are prerequisites to scale, something many ambitious business owners miss.  

S is for Scalability

The chances are you can take a fairly tactical approach to the first two parts of the formula but when it comes to scalability, a strategic approach is essential. Developing long, medium and short-term objectives based on your target market, proposition and key differentiators, deploying resources effectively and aligning the entire firm with the plan – these are all key activities that go to form a solid strategic plan and you need this to scale.

A sound strategic planning process should also help with the difficult decisions that relate to capacity planning and investment for the future. Investing in people before you need them is particularly risky, but critical to scale. Knowing when your team hits capacity allows you to determine when those poorly named ‘fixed costs’ will change, which will increase your confidence when it comes time to hire.

Ask yourself; does this decision improve or reduce our scalability?

Of course, the development of a strategic plan is one thing, but having the discipline to execute it is an entirely different skill set and one that presents the greatest challenge to many business owners. 

x is for Purpose

And so we come to the x factor. The key variable that can divide the benefit of the other good work. It’s the one bit of the formula that cannot be engineered and requires careful consideration. I am of course referring to one’s motivation, or to put it another way, one’s purpose. This should not be confused with ‘meaning’, which relates to the past and is largely psychological. On the contrary ‘purpose’ is largely future-orientated and hopefully relates to others as well as you. Identifying people’s ‘why’ is very trendy right now, but it’s always been critically important to understand whether an individual is predominantly driven by a ‘will to money’ or a ‘will to meaning’. One’s motivation frequently determines the outcome, particular when there’s much at stake.

Why is all this important? Well, you probably can’t scale the firm without involving other key people and putting aside the specifics of ownership and control, your ability to understand and remain aligned with your team’s motivations, is critical to your ability to create a truly valuable firm. Creating a strategic plan is important, but executing it is critical. Things change, and one must remain lose in the saddle – tough decisions are inevitable – strategic execution being as much about what’s left out as what’s kept in. You might have majority control but are you willing/able to use it? Illness, divorce, fights and many other things besides, have a far greater impact on the ultimate destiny of a firm, than client complaints, competition, regulation and so on. Remember, our capacity for self-sabotage knows no bounds…

Ask yourself; what are we sacrificing by making this decision and are our motivations aligned in doing so?

B is for Bankability

If you’ve got all the other aspects of the formula right, you should have a bankable asset – one you can sell as a going concern, should you choose to at some stage. But is it as simple as that? Well, no it’s not actually. You’ve still got to sell it, and this comes with its own unique set of challenges.

One key characteristic of businesses that are attractive to a purchaser, is the ability to prove the value, both in terms of accretive profits and strategic and/or commercial advantage to the acquirer. How is this done you ask? Simple. Take the objectives from your plan, overlay the firms’ actual performance, convert the year-on-year results to meaningful ratios and track them over time. Record key decisions taken along the way and when it comes time to ‘open the kimono’ you’ll be able to explain how and why, you arrived where you did.

Your aim at the point of sale is to prove to the acquirer that they are getting a profitable (viable) business that consistently delivers to existing and new clients/customers (capability), one that’s growing exponentially in markets/niches that are attractive, understood, matched to the capabilities of the firm (scalable) and managed in a rational way (purpose-led). Do this and you have every right to demand a full price for your business (bankability).

Ask yourself; can we demonstrate the value of our business today and show how the omens look good for the future, regardless of who owns it?

 

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