Business owners start companies for a variety of reasons, but at the core is the entrepreneurial spirit of believing that anything is possible. Businesses start as ideas which a person believes will fill a void in a marketplace and provide people with a good or service. Some businesses start out well capitalized and some begin on a shoestring budget, but either way the first years are trying and the light at the end of the tunnel seems to get further away until one day the owner looks up and realizes they have made it. The business cash flows on a monthly basis, the owners can begin to draw salary, pay off debt and eventually the equity owners can earn a distribution or dividend. This is the moment where many business owners look around and try to determine exactly what it is they have created. For some owners the work has produced a company, but for most the result of the labor is a job.
Every business owner’s goal is to create a company and to be the owner of the company which generates cash flow and ultimately renders the owner a very wealthy person. However, the end result of most businesses is not a self-sufficient ATM, but a business which the owner cannot escape. The simplest way to determine whether a business is an actual company or simply a job is to ask the question; if the owner were to not show up to work, would the cash flow of the company erode? If the answer is yes, the cash flow would decrease if the owner left then the end result is most likely a job. If the owner did not show up and the cash flows would remain unchanged then the business is a true company. Every business creates value through their cash flows which provides the owner an exit strategy of selling the business.
Buyouts of companies are often talked about on the upper end of the market place as mergers and acquisitions. Often these terms are thrown around when talking about Wall Street companies. However, M&A activity takes place across businesses of all sizes, and at the core of every valuation is a number called EBITDA or earnings before interest, taxes, depreciation, and amortization. EBITDA is a very accurate snapshot of the cash flows a business has based upon the actual business activities. Buyouts are typically based upon a multiple of EBITDA such as 3x or 5x EBITDA. For instance one of the reasons the Facebook IPO was difficult for investors was the 100x earnings valuation. Consider Apple is only valued at approximately 16x earnings, and most small businesses sell at 3-5x. The buyout multiple is typically based upon the strength of the existing cash flows and the potential for growth and expansion. Many small businesses are never purchased and most professional practices have the same issue because the value of the business, the cash flows, are directly linked to the efforts of the individual who owns the business. This is why many small businesses plan for retirement by purchasing the real estate they operate from and selling the real estate as an asset at the end of the life of the business.
The single best method for preventing your business from turning into a job is to script everything from the beginning. The act of scripting things from the beginning is tedious and time consuming. Scripting means writing down each task and the best way to do it as the business grows. A business owner will be forced to do every task in the beginning because of a lack of time and employees. This is the best opportunity to write down how to do everything and create checklists for the best procedures. As the business grows and new employees are hired the employees are provided with manuals for procedures which the owner understands. Reducing things to a checklist is the best means for making every employee replaceable and making sure the business operates like a Fortune 500 company. If there is an issue the owner’s role will be to step in, help fix the problem, and then improve the script. This process should continue as the business grows to ensure the most up to date manuals and procedures are used for operations.
Creating a job is not a bad thing, the owner is the boss, the hours are flexible, and typically the pay is good. However, the biggest event in any businesses life cycle is the sale of the business, so it is important to understand what to expect when that time comes. If the owner cannot leave the business without the cash flow decreasing then the owner should look to purchase assets to invest over the course of their career, or begin to work on stepping away and scripting issues as they arise. Creating a company with standalone cash flows is not an easy task, and scripting does not make the hours shorter. However, in the end the reward is worth the extra work as a company is built that can be sold. The next time an owner says “if you want something done right you have to do it yourself,” they should stop and realize that if the task was not done right it is because the proper instructions were not given. Scripting will make sure adequate instructions are provided and help a business identify issues while improving the company’s value which could ultimately translate into a buyout.