|Ira Friedman is the CEO of Bay Audio, a
manufacturer of custom speaker solutions.
He holds an MBA from the Harvard Business
There’s a lot of talk about mergers and
payout formulas in the CI business,
with owners and buyers alike trying to
nail down realistic valuations. There
are a few tried-and-true formulas in
the world of high finance, but none of
these adequately capture the value of
a typical CI business. Why? Because
CI companies have present value–with
measurable cash flow–but unpredictable
and unmeasurable future value. Future
value is what buyers are looking for,
and a CI business is all but impossible to
value, making the de facto value zero.
Two Common Valuation Methods
Companies with loads of assets, Dish
Network for instance, can be valued
on the strength of their balance sheet.
Infrastructure has value, and it’s easy for
a buyer to project the replacement cost of the company’s infrastructure.
Throw in some projected subscription income and you’ve got a relatively
stable company valuation. Even though Dish struggles to make a profit,
it has a market valuation of more than 22 billion dollars. Its high value
comes from its assets.
Now look at a company with limited assets, but lots of intellectual
property, like Dolby Laboratories. The stock market values Dolby at more
than three billion dollars. And rightly so, because its licensing income is
easy to predict, and the company’s costs are well contained. No assets, no
products for sale, just fantastic intellectual property driving the value of
Why CI Companies have Unpredictable Value
Unlike Dish Network, a CI company has no assets to speak of. And unlike
Dolby Labs, the CI company has no intellectual property to leverage.
Without assets and intellectual property, setting a valuation gets tricky.
|A CI company has no assets to speak of and no intellectual property to leverage. Without assets
and intellectual property, setting a valuation gets tricky.
Looking at a CI company from another perspective, an acquirer will
ask, “What will your next year’s sales and expenses look like?” In response,
most CI owners will tell you that they’re fairly confident that next year will
be as good as, if not better, than this year. But then the acquirer asks the
owner, “And what will the business look like if you leave?” To which
the owner replies, “I don’t know.” That’s because the owner of a CI
business is the business. He is most likely the greatest generator of sales,
the most attentive to labor costs, efficiency, and productivity, and the most
likely to influence the disciplines that the company undertakes. That’s a
lot of responsibility placed on one individual, and it makes the owner’s
departure a critical change in the health of the business. So, unfortunately
the honest answer to, “What is the company worth without the owner?”
is, “Probably nothing.”
Think Like a Dentist
CI companies look and feel much like dental practices. Dentists don’t sell
their practices when they choose to retire. They ease out of the business
by taking on a junior partner and slowly, methodically, turning over the
patient load to the younger dentist.
During the first year of the partnership, Dentist the Elder enjoys
vacationing a week each month while still drawing her same salary. Within
a few years, she’s taking off half the year, with no salary decrease. And five
years later, she’s living full time in Maui, drawing a salary for several more
years until Dentist the Younger owns 100 percent of the practice.
This is called a planned transfer of ownership, and it works precisely
because the dental practice has no assets and no intellectual property.
Instead, like the CI dealer, the dental practice has a database of clients
that are introduced to the new partner and choose to remain patients of
the practice, even as it undergoes managerial change.
The Real Value of the Dental Practice
Dentists learn, through financial planning seminars, to live on 75 percent
of their income. That means for every $100,000 that they take home,
they live on $75,000, and put $25,000 into long-term, stable, consistent
investments. Like tax-free municipal bonds.
Dental practices and CI businesses have the benefit of ongoing cash
flow. Socking away money for retirement every month is ingrained in the
field of dentistry. (Not so in the CI world, and the reasons are too many
to discuss here.) Dentists plan for retirement by capturing day-to-day cash
flow in the early years and ceding the business to a junior partner as they
This is the only valuation model that I see working in the CI world.
Not mergers. Not selling to a wealthy client. Simply saving for retirement
today, living on 75-percent of cash flow, and planning for top management
to slowly ease the owner out of the business as he reaches retirement
age. Which puts a tremendous onus on improving cash flow, driving
efficiencies, and building a competent managerial team.