guest commentary by David Potts
Editor’s note: David Potts is a certified public accountant with more than 33 years experience. Although every effort is made to provide you accurate and timely tax information, it is general in nature and not specific to your facts and circumstances. Consult a qualified tax professional to discuss your particular case. Feel free to e-mail topic suggestions or questions to firstname.lastname@example.org
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I read Stephen Covey’s classic book, "The Seven Habits of Highly Effective People," the year it was first published, in 1989. It since has become a business classic for cause. Business speak has adopted Mr. Covey’s habits as customary terms: be proactive, begin with the end in mind; think win-win.
I was 31 when I first read The Seven Habits. Twenty-five years later, my understanding of the second habit, Begin with the End in Mind, has morphed somewhat. In 1989 I had a grandparent; today I am a grandparent. As a baby boomer, I am beginning to see the end with more clarity. Most baby boomers can relate to this changing mindset caused by time.
There are millions of privately owned businesses that, over the next 15 years, will either be sold, transferred to a younger generation of family members, or closed with their assets liquidated. If you are a baby boomer who owns a business, you are beginning to wonder where you and your relationship to your business will be in the next 10 or 15 years. If you aren’t asking these questions you should.
You have invested your blood, sweat and tears in your business. Ask yourself that nagging and perpetual question, “Have I only created myself a job or have I built a self sustaining business with value?”
For most business owners one of life’s greatest mysteries is how much their business is worth. If as an owner you have only created yourself a job, then your business’s value will be closer to the value of its tangible assets less its debt. If you have built a business sustainable without your constant presence, your business’s value will be greater than the value of its tangible assets. This intangible value is referred to as goodwill.
Most business owners have a general concept of what goodwill is but if asked to define goodwill, most would have a difficult time doing so. Here is the definition from the International Glossary of Business Valuation Terms:
Goodwill – that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors separately identified.
Now that explains goodwill in a way that all the word understands! But just in case, let me offer my explanation. Goodwill is all the intelligent actions a business’s management engages that adds to the company’s cash flow. A trained workforce with low employee turnover adds to the value of goodwill. Well thought out systems and processes that make a company’s operations efficient adds to the value of goodwill. The company’s culture adds to goodwill. Even a company’s accounting and financial reporting systems that provides timely and accurate financial information adds to the value of the business’s goodwill.
If in the end a business owner hopes to be rewarded for the investment of his life in his business, if he hopes to get a big payday when the company’s ownership is transferred in the future, that payday will be because of the value of that intangible asset called goodwill.
A business owner’s big pay day isn’t just dependent on the creation of goodwill. Goodwill must be transferrable to a new owner with the other business assets. If a business owner is so jealous of the business’s proprietary knowledge or he is paranoid of losing control of the company’s operations because “nobody can manage the business as well as he can”, then trouble looms for the continuation of the business when the owners leaves. And all owners eventually leave.
The basic secret of creating goodwill that can transferred is in developing a management structure with a trained workforce that includes written documentation of the company’s operating policies and procedures. And that is where most privately owned businesses fail. They never commit to written documentation. Admittedly this is a bit over simplified. Documentation of inadequate processes or inefficient procedures is not profitable. But the writing process to document polices and procedures sometimes begets discovery of inefficiencies that can be corrected. Why? Because writing requires analysis and thought.
The great thing about owning a business is that you get to control what the business does. As a business owner, you have the power! You have the power to create value or destroy value.
All business owners I know that have ever bought or started a business did so with the intent of making money. Over the years many owners have let day to day operations replace the focus of building the business which has stunted the growth of income and cash flows.
But if you are at the stage in life where you can see your end in your mind, and if you need or want a big payday as you transition out of your business, you might need to refocus on building the value of your business. The payoff can be huge.