Unless you own a pet store that sells these cute amphibians, the answer to that question is not immediately clear. But it’s true, FROGS can drive up the value of businesses in all industries!
Even weirder, if you add the 3 SEAS to the FROGS, the value growth can even get higher! I know, you think I’ve lost my marbles, but it’s true (not the losing my marbles bit!).
FROGS and the 3 seas (apologies, this should be the 3 C’s) are the drivers of value growth in any business. Let’s explore what I mean by this …
FROGS And The Three "C"s
Business value is important to all businesses, but it is transferable value – what a business is worth to a buyer without the owner’s presence and involvement in the business – is what delivers real wealth for you as a business owner.
Transferable value can be increased by having strong value drivers. Strong value drivers make a business a desirable acquisition to buyers. Buyers will pay top dollar for a business with well-functioning value drivers because these drivers inherently contribute to increased cash flow and financial performance by showing three attributes: –
1. Sustainability
2. Predicability
3. Transferability
This is where the FROGS and the 3 C’s fit in. They are acronyms for the eight most important value drivers that will turbocharge the value of any business. These value drivers are: –
- Financial Controls, Performance & Projections
- Revenue – Sustainable & Recurring
- Owner Dependence & Team Talent
- Growth Strategies
- Systems
- Cash Flow
- Competitive Advantage
- Concentration of Customers & Suppliers
This list is not exhaustive. Depending on the type of business you run, other value drivers may create and increase transferable business value. However, these value drivers are nearly universal.
Here’s a short description of the FROGS and the 3 C’s …
1. Financial Controls, Performance and Projections
This value driver has two aspects.
The first relates to financial controls or reporting. Many businesses lack reliable financial reporting to such an extent that buyers can’t determine what the business has or track the source of its revenues. Usually, this problem is correctable, but it takes time. More importantly, sloppy financial reporting can indicate to buyers that there’s an underlying problem, the most benign of which is that owners and managers lack a clear understanding of the financial performance of the business.
You as the owner must have a firm grip on the financial condition of your business. This is a critical responsibility because you are the one signing off on all the loans and other obligations of the business.
The second aspect is less apparent but more important.
If you want your business to grow substantially and quickly, the business “must be fed.” Creating a growth plan for your business is great, but you must also project the cash flow cost of implementing that plan. If growth needs to accelerate substantially and quickly to meet your goals, it may take more than the cash flow your business produces to support it. Bank or other financing should be secured before you find yourself in the middle of expansion and short on cash. In this case, generally speaking, a full year allows enough time to arrange financing where needed.
2. Revenue – Sustainable & Recurring
Like the financial value driver, this driver also has two aspects.
1. Sustainable, recurring revenue.
2. Having products or services resistant to commoditisation.
The reason sustainable revenue is a value driver is because buyers much prefer a business that makes money hand over fist to one that struggles to eke out a profit. Even better still, is there a way for the business to create one or more recurring revenue streams? This makes the cash flow more consistent and gives buyers more appetite to bid up the price of a business.
Another question is whether the products and services of your business are viewed as commodities by customers. It’s difficult to create any useful product or service that can’t be quickly imitated and commoditised by competitors, so continuous innovation, in addition to the other strategies mentioned above, is crucial for building transferable value.
3. Owner Dependence & Team Talent
To be valuable to a buyer or any future owner, a business must be able to function without being totally dependent upon you as the owner. The business must be able to succeed and grow without you at the centre, or like on a bicycle wheel, at the “hub” of all activities, as the employees become mere “spokes” that cannot operate independently of you.
Even better still, having “next-level management” that runs the business without your presence is the mother of all value drivers. Having top management talent is the most critical value driver because in the end, management oversees the installation and growth of all other value drivers.
4. Growth Strategies
Even if you expect to retire tomorrow, it makes sense to have a written plan describing future growth, and how you will achieve that growth in the context of industry dynamics and demand for your business’s products.
This growth plan may include developing new product lines or augmenting existing ones, marketing plans, growth through the acquisition of other companies, expansion into new territories, or increasing manufacturing capacity. A detailed and properly communicated growth plan helps attract buyers, especially if your previous growth plans have allowed you to successfully attain your goals.
Combining next-level management with a written growth plan is a powerful one-two punch for enhancing transferable business value.
5. Systems
Establishing and documenting standard business procedures and systems demonstrate to buyers that the business can maintain profitability after the sale and after you (the owner) have exited. Properly established and practised systems also create cash flow and increase its sustainability.
I cannot understate the importance of this value driver. In short, savvy buyers—without exception—look to this value driver. If it is absent or weak, buyers move on.
Creating and documenting systems and processes is crucial to building business value to the point at which the owner can leave their businesses on their terms without fear that they will fall apart without them.
6. Cash Flow
Ultimately, all value drivers contribute to stable and predictable cash flow. You can increase your cash flow by focusing on ways your management team can operate the businesses more efficiently e.g. increasing productivity and decreasing costs. However, this alone may not create sufficient growth to allow you to achieve your objectives on time.
Additionally, this value driver depends on the effective operation of other value drivers.
Growth throughout the entire business infrastructure is pivotal to growing cash flow. For example, growth in the number of customers you serve requires growth in customer service. When the quality of the customer increases, or when the business adds or changes product and service offerings, the entire organisation must grow in lockstep.
This means more (or better) management, training, and accountability that ultimately improves business value.
7. Competitive Advantage
Competitive advantage is why your customers buy from you instead of your competitors. A good way to determine whether there is a competitive advantage is to compare the profit margins and growth rate of your business to that of your competitors. If the margins are considerably higher for your business, it’s a good bet that you have a competitive advantage. If so, you should determine what it is and protect it.
It’s possible that the business has a competitive advantage and you know what it is. However, if you don’t, you’re likely competing on price alone, which means your business is susceptible to commoditisation. If the business has a competitive advantage, apart from protecting it, more importantly, you need to promote it.
8. Concentration of Customers & Suppliers
Buyers typically look for a customer base where no single client accounts for more than 10% of total sales. A diversified customer base insulates businesses from the loss of a major customer.
For example, if the business had three top customers that generated 40% of all sales, a buyer would be concerned if one or more of them left upon learning that you (as the owner) had sold the business. To a lesser extent, this may also concern key employees, co-owners, or family buyers if the biggest customers are loyal to you rather than to the business itself or other employees. Thus, customer concentration is a risk factor to avoid, regardless of the exit path you choose.
Likewise relying on a small number of suppliers for the business is risky. A good example of this risk was the global supply chain issues from the COVID pandemic. Not just businesses, but countries are now looking to diversify supply chains and not rely on one or two countries to supply their critical goods and services. Accordingly, a buyer will pay more for a diversified supplier base as the supply chain risk is mitigated.
Delay Has Consequences
The sooner you begin to install or improve these eight value drivers in your business (called a value enhancement process) the more the business, and you, will benefit.
A common statement by business owners is that they will start working on the value drivers when they’re ready to transition or exit the business. However, if you (as the owner) wait until then, major issues can arise.
Firstly, if you want the maximum value from your business, the workload to build transferable value with a value enhancement process remains the same, whether or not they’re ready to exit.
The only difference is that if you wait until you are ready to transition from your business, there’s a high probability that you will have insufficient time to test and improve the performance of the respective value drivers in the business. For example, allotting time to pursue alternative growth strategies (e.g., replacing non-performing management) or systemizing the business is crucial, and without that extra time, owners can trap themselves. This is where you could leave a lot of money on the table if you don’t plan and execute the value enhancement process early enough.
Another issue from delaying the value enhancement process is the loss of passion and drive in owners to do the necessary work (because they’ve either had enough or can see the light of the exit door). Once you lose this passion and drive, the energy and growth of your business will probably suffer.
By waiting, you also forfeit a more pleasing ownership experience, because at the heart of value enhancement is making you replaceable while concurrently increasing cash flow and profits. If you delay the process, you will have forfeited years of increased cash flow, profits and time spent doing other things in life.
The Time Is Now
Growing transferable value is vital for any business’s sustainability and wealth creation. Insufficient transferable value is the principal cause of failure in exit planning.
So the time to act and start your value enhancement process is now, while you still have the time to improve the performance of the FROGS and the 3 C’s.
These eight value drivers will ultimately set you on the road to successfully transition out of your business at a time of your choosing, and for the wealth you need.
The information contained in this article is general in nature and is not legal, tax or financial advice. For information regarding your particular situation, contact a lawyer or a tax or financial professional. The information in this newsletter is provided with the understanding that it does not render legal, accounting, tax or financial advice. In specific cases, clients should consult their legal, accounting, tax or financial professional. This article is not intended to give advice or to represent our firm as being qualified to give advice in all areas of professional services. Master Planning is a discipline that typically requires the collaboration of multiple professional advisors. To the extent that our firm does not have the expertise required on a particular matter, we will always work closely with you to help you gain access to the resources and professional advice you need.
Any examples provided are hypothetical and for illustrative purposes only. Examples include fictitious names and do not represent any particular person or entity.
