The Numerator or the Denominator: Which Drives Value in a Family Business?

Family business value

I recently completed a one week course to obtain my Certified Valuation Analyst (CVA) designation. With an abundance of family-owned businesses expected to change hands over the next decade, I figured this training would come in handy.

During the course of the week, there was an overwhelming amount of technical information presented that cited case law, professional standards, and the various requirements to prepare a formal valuation report. However, the concept that really stuck with me was the formula to calculate value.

The valuation formula simply takes a defined revenue stream and divides it by a rate of return. Or, to look at it another way, divide the revenue stream by its related risk. This formula yields the value of a business.

I began to think about how this simple formula applies to so many facets of running a family-owned business. To the extent that you can influence the numerator or the denominator in the equation, you can make a substantial impact on the value of your family business. For instance, take the numerator or the “benefit stream.” Creating higher margins, managing costs, or growing sales can directly increase the value of your business despite the inherent risks. On the flip side, managing the denominator or the “risk” can yield a substantial impact to the value of the business.

This is where having proper corporate governance, a trained management team, and a succession plan all come into play. Think about the value of a high margin business with low risk, as opposed to a lower margin business whose owner is the chief, cook, and bottle-washer. Just imagine what the value of your family business would be if you were to make a concerted effort to influence one item in either the denominator or the numerator over the next year. Now, picture what your family business would look like if you were to do this each year for the next five or even 10 years!

Steven E. Staugaitis, Kreischer MillerSteven E. Staugaitis is a director at Kreischer Miller and a specialist for the Center for Private Company Excellence. Contact him at Email or 215.441.4600.

 

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