Business performance measurement and management promote the use of carefully
selected key performance indicators to evaluate the performance of a
company, its management and employees. Management theory has long recognized
that the primary purpose of a company s management is to maximize
shareholder value. For large companies with stock that freely trades in
public securities markets, this is a simple process of monitoring stock
price. For small, private companies the situation is quite different.
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Large, public companies have many stockholders that elect a board of
directors, who in turn hire the key executives. This separation of ownership
from management does not exist in small, private businesses. Often these
three groups (owners, directors and management) are comprised of the exact
same individuals. Small businesses become extensions of their owners in many
ways including their objectives. Owners are typically more concerned about
objectives like: minimizing taxes, maximizing personal income, maintaining
personal lifestyles, minimizing the assets held within the business, and
protecting personal assets. Pursuit of these objectives tends to minimize
the value of small businesses. Owners often are not very interested in the
value of their businesses until something happens that makes it important
like a divorce or wanting to retire.
Do small business owners really not care about business value? Or is it
because they are not accustomed to having it available? Business valuations
cost thousands of dollars, so small businesses can t afford to get one on a
regular basis. If it is not practical to measure something, it becomes
unimportant. If the value of small businesses were readily available, like
public companies, then the owners would become interested in it. Quite
possibly they might shift their business objectives to maximize value.
Those who have tried to monitor business value without paying for regular
business valuations often used industry rule of thumb formulas. While
formulas are easy to use they have some serious drawbacks. They are based on
data of unknown quality and quantity. The formulas are expressed in ranges
that produce widely varying values. They do not take into consideration the
unique facts and circumstances of each specific business.
There is a better solution. Much more information is now available about
the sales of small, private businesses. There are a number of sources that
have collected data on thousands of transactions over many years. These
databases provide actual market data. Professionals and commonsense suggest
that quality market data is the best source for appraising any property. The
databases have some shortcomings, too. The information is limited to basic
data like annual sales, asking price, cash flow, selling price, etc. And
some types of businesses don t have many transactions. The databases work
best when there are many similar transactions, so common businesses like
restaurants are good candidates. Averaged figures from many transactions
offset any extreme or unusual cases. The ratio of selling price to annual
sales, or selling price to cash flow is typically used to calculate a
specific business s value.
These databases are available by subscriptions that are not cheap. So it
is not practical for a small business owner to access them directly. And the
professionals who do subscribe aren't prone to sharing them. There are a few
companies that for a small fee will search the databases for transactions
involving similar businesses, calculate the average ratios, and use them to
calculate the value of a small business. These low cost business valuations
based on actual market data are great tools for making business value
readily available for most small businesses. Using this tool, small
businesses can finally start using business value as the ultimate
performance indicator, just like public companies.
