How does reliance on an owner or other individual impact business valuation?
Business evaluations are crucial to the sale of a company. A high and accurate valuation allows owners to sell their company at a premium, while a low-valued one is unlikely to attract any interest. Our commercial litigation team acts in a variety commercial, business, shareholder, and investor disputes, nationwide. In this context, it is important to consider that valuation can be an important (and often critically important) aspect of a dispute. Understanding how a valuer might proceed can help determine the outcome. This impacts the cost-benefit analysis in any (all of) litigation.
When valuing a business, it is important to consider how closely the company is tied to its owner. A business that is too dependent on one person can affect its value and saleability. Buyers will prefer companies that are self-sufficient. This blog post explains how owner dependence impacts valuations and how it can be reduced to improve value. If you’re involved in a dispute over a business or shares, you should know that valuation is just one factor that can affect your chances of success and likely outcomes. Contact a member of the Helix Law commercial litigation team for more information and to discuss your dispute in greater detail. We will be happy to assist you. What Is Owner Dependence? Owner dependence is the extent to which an organization relies on their owner, proprietor, or key personnel in order to function properly. In an owner-dependent business, the day-to-day activities, such as customer service and operations, are carried out primarily by one person.
For instance, the owner of a real estate agency might be the sole point of contact with customers while also managing the financial accounts and making all business decisions. This can appear to be a cost-effective way to run a business in the short-term.
However if the person suddenly can’t fulfill these roles, such as due to illness or leaving, the operational disruptions, and knock-on effect could be substantial, and at worst, it can drain much of the value from the business. How Owner Dependence Affects Business Value
A company may seek a valuation for a variety of reasons, but the most common one is to sell. Expert valuers will take into account a variety of factors, such as the business’s assets, liabilities and revenue. A critical factor is the way the organisation is run and managed. This includes assessing whether it can maintain profitability without the owner.
A business that is too closely tied to its owner will not be attractive as an investment. The new buyer of the business will need to make some changes to the operation once the owner leaves. The purchase is therefore fraught with risk, reflected by a lower price and sometimes a reduced valuation.
Why Buyers are Cautious about Owner-Centric Business
Purchasers seek an investment that is beneficial to them, which means minimal disruption, maximum returns, and the best chance of long-term success. Potential buyers are concerned about owner-centric businesses because:
They don’t always have the right systems to adapt the organisation. Therefore, the company will likely have more difficulty expanding.
Practically, purchasing an owner-centric business can also lead to extended due diligence and negotiations, which is off putting for some.
If there is only one person who knows everything about the business, it could lead to gaps or ambiguities in the information.
Clients develop close relationships with people who are closely tied to the company. When a person leaves, customers may not want to maintain their professional relationship.
A buyer may find it difficult to separate the brand identity from its owner, which can make growth more difficult.
- Owner Dependence and Its Effect on Sale Price
- There are several effects this type of business can have on value:
- Price
- The most obvious impact of owner dependence is on sale price. Buyers only offer premiums for companies that they believe will continue to run smoothly after the takeover. They expect a lower price because of the risks of instability, uncertainty, and lack growth.
- Marketability
Marketing a business like this is usually more challenging, as investors may not have confidence in the purchase from the outset. Initial interest can quickly fade as potential buyers pull out. Marketing a business for sale can be costly, especially if there is no interest for a long period of time.
Structure the Deal
The contract for a business that is owned by the owner will look different, as the buyer wants to minimize risk. For example, an investor might require the existing proprietor to stay involved in the company during a transitional period to facilitate a smooth handover.
Parties may also agree to include an “earn out” clause, which makes part of the sale price dependent upon future performance. These types of agreements can be complex and expensive to agree.
Transition period
The current owner is often required to remain involved with the company even after the sale. This transition is uncertain as the owner might not be able or willing to stay involved for a long enough period.
Transitioning Client Relationships for a Successful Sale
A crucial consideration for a company to sustain its growth following a purchase is transitioning client relationships. Customers who are used having a direct relation with a certain person and are not warned about the new management could decide to go elsewhere. It is therefore vital to manage this transition carefully. To maximise customer retention, businesses must gradually transfer client relationships and communication to the new team prior to the sale. This allows clients to get familiar with the new management, while still feeling confident about the involvement of the existing owner. This approach helps to maintain consumer trust, and prevents them feeling blindsided after the takeover.
Companies may want to consider creating a dedicated transition team and appointing several new points of contact to introduce themselves to their clients.
Steps to Reduce Owner Reliance and Increase Value
To maximise business value, owners should consider taking the following steps:
Delegate tasks: Delegating essential responsibilities not only eases the burden on the individual but also means the company can function without their involvement. Owners can adapt gradually by doing this.
Keep detailed and accurate records: Keeping accurate and detailed records allows a new investor take over easily. Create a leadership team. Appointing others to lead key areas of the organization will improve its longevity and encourage employees to stay for longer.
Building brand independence: By separating the brand from an individual, the company will continue to be successful even if that person leaves. Rebranding is a good example of how to achieve this. Nurture client relationships. Change can be intimidating for customers. It’s important to reassure them that the company will still serve their interests after the sale.
Frequently Asked Questions
What are the factors influencing business valuation?
A number of factors affect a company’s valuation. These include its assets, liabilities and revenue, as well as profit margins, the market position and growth potential. The value of a company is also influenced by its customer base and competitive advantage. All of these factors are affected by whether or not the company is owner-centric, and if it is able to operate independently from a specific person.
- Final thoughts
- When you are involved in a dispute or litigation, it is important to think about how to best position yourself to achieve the best outcome. This will mean either maximising or minimizing the value of your business or shares depending on whether you’re the buyer or the seller. Owner dependence can have a significant impact on a company’s sale price, value, and marketability. A business that is too closely linked to its owner can cause buyers to be uncertain, as they worry about having to invest additional resources to maintain the operations after the sale. They risk losing clients, struggling to maintain brand identity, or lacking knowledge after the owner leaves. Investors are faced with lengthy negotiations and complex contracts that can lead to lower offers.
- We typically hire accountants to provide us and our clients a detailed briefing on the factors above that are important to help maximise or minimise valuations, depending on what we want to achieve.
- Organisations can improve their value by taking specific steps to reduce owner reliance. Owners can make their company more attractive to investors by delegating tasks and developing a leadership group. They can also transition client relationships. If you are a partner or shareholder in a business that is currently in dispute and you’re considering valuation and other exit strategies, our commercial litigation team will be happy to assist you. Our team is experienced in handling disputes of this nature and can help you prepare for a valuation with favorable terms or take other steps to improve your position. We are happy to help you determine the best next steps. Helix Law can provide you with more information.
