What drives value? Featured

7:00pm EDT December 31, 2006

The number of valuable, best-run private companies could fit neatly into the smallest part of a bell curve. These companies share characteristics like strong leadership, focused strategy and sound infrastructure. And because they invest in these “soft-side” business issues, their valuations are greater than most.

“Most entrepreneurs get into business because they are risk-takers, they like the flexibility to run their businesses how they want, and they work well independently,” says Mario Vicari, director of Kreischer Miller in Philadelphia. “But the companies that produce the most value learn, over time, that even though they are entrepreneurial, they need structure and a plan.”

Smart Business asked Vicari to discuss how business owners can build value and take advantage of their ability to be nimble and react to market demands.

How is the value of a private company determined?

Though private companies tend to be smaller than their public counterparts, they can still be very valuable to the owners. Because they are privately held and their financial information is not readily available, the value of these companies is often difficult to grasp. Still, it is very important for private business owners to understand the value of their companies because most of the wealth they accumulate in their lives is in their businesses. That is usually their key asset.

Generally speaking, the more cash flow a company generates, the more valuable it is. The question then is, How does a company increase its cash flow and, therefore, boost the value of the business? The best way is to address issues like leadership, strategy and management.

What kind of leaders head up valuable businesses? What qualities do they share?

Many private companies tend to be too disorganized; almost too flexible. They don’t have a sound business structure and they don’t engage in planning. They adopt an attitude of ‘my grandfather did it that way, my father did it that way, I’ll do it that way.’

But the world has changed dramatically. You can’t grow and drive value in your business with this mindset. The best leaders of private companies are forward-looking and working toward a destination. They engage in business planning and devise strategies to reach their goals.

An important part of most strategies is to target customers and markets they can serve uniquely. Owners of valuable businesses are discriminating about what markets they will serve and the products they sell.

How does defining a customer and market niche tie into cash flow?

Companies that drive the most value don’t try to be all things to all people. They don’t try things they are inherently not good at because it is harder for them to make money that way, and they know that.

Focusing on target customers and markets is a huge deal because it affects margins and cost structure. Focusing on a niche market usually results in higher margins because you can become excellent at serving that niche and you can organize the cost structure of the company in a way that allows you do be efficient. You may sacrifice volume to do this, but normally margins will be strong.

What about great employees?

Many private business owners hesitate to hire people more skilled or talented than they are because they are intimidated. But talented executives and managers can add unique experiences and insights to a company. The most valuable companies that I work with understand the value of investing in key people.

How does infrastructure have a direct impact on a company’s ability to increase cash flow and, in effect, the value of a business?

There is not a direct correlation between the value of a business and its infrastructure. But all of the departments behind the scenes — such as customer service, accounting and technology — exist to keep that sales engine moving and information flowing to make good decisions.

Infrastructure and management systems provide information and other resources so a company can get to its customers in an efficient manner and serve those customers well. But because building these systems is an overhead cost, some owners resist. They view investing in infrastructure as decreasing profit because they have to spend money. Actually, they should consider the value those services add to the business, which eventually translates into more cash flow and more value.

What about the owner who argues that his pay is significant, so the company must be valuable?

There is a difference between pay and what your company will be worth later in life. If you don’t organize your business in a way that it can run without you, then it won’t be of any value to anyone else because it is too dependent on the owner. You need to create systems, bring in the best people possible, and identify how you will go to market and who your target customers are. Then stick to your niche.

MARIO VICARI is a director at Kreischer Miller in Philadelphia. Reach him at (215) 441-4600 or mvicari@kmco.com.