A false dilemma is a fallacy based on an “either-or” type of argument. Two choices are presented (when many more likely exist) and the claim is made that one is acceptable and the other is not. Examples come in all areas of our life, including politics (“Donate to my campaign if you care about the future”), advertising (“If you don’t use our beauty products, you’ll never look youthful”), and sports (“If you’re not with my team you’re against my team”).
Business owners also face a false dilemma—choosing to focus on business value versus business income. The choice is not mutually exclusive, and business owners would do well to recognize this is a false dilemma by shifting their mindset. In last month’s blog, we covered how business owners should maintain a successful business exit mindset. This month, we focus on how business owners need to see past the false dilemma of value versus income, and instead focus on value and income.
Many small business owners have “lifestyle” businesses that generate a nice income for them. The focus of a lifestyle business is usually on business income, but income alone doesn’t mean the business can be sold or has a transferrable market value. When business owners begin to focus on the business value as well, every decision is seen through a different lens. As a business owner, the next time you hire someone, purchase new equipment, or invest in your business, the questions “What value does this add to the company?” and “What will this do to my income?” may result in very different answers. If your only focus is on the expense, you will likely think twice about spending the money, but if you think about the value being created, it forces you to think a bit deeper.
So why focus on business value and business income? From my experience working with business owners as a CERTIFIED FINANCIAL PLANNER™ professional and Certified Exit Planning Advisor, often the business is one of the largest assets on a business owner’s balance sheet. Business value is calculated based on a fairly simple formula:
Adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) x Multiple (of tangible and intangible assets) = Value
If a business is not transferable or able to be monetized, the value may as well be zero. However, if a business owner has developed a transferable business, there are ways to further increase the overall value. Every industry trades in a range of multiples that will vary depending on the size of the company, industry, and private capital market; economic circumstances; and the availability of businesses in the industry. Private capital markets control the range of multiples; weak companies trade at the lower end of the range, while premium companies trade at its higher end. What makes a company weak or premium is its intellectual capital and the various risks associated with the specific business. Although you don’t control the range, you have the ability to control where you fall within the range of businesses for sale.
As you begin to evaluate decisions through the lens of business value, you can evaluate the difference between the cost of a decision and the benefit using an EBITDA multiple, which provides you the incremental value of each decision. And remember, the value creation process should not be limited to you—the owner of the company—but the idea should permeate the management team, which may require a paradigm shift and some culture change. Adopting metrics to reinforce “value thinking” in strategic planning and update meetings is helpful in keeping business value on equal footing with business income. Focusing on value will likely drive more income, but focusing solely on income does not necessarily drive value. It is critical to begin to shift your mindset as a business owner from falling into the false dilemma trap and instead focus on making choices that will add to your income and increase business value.
CCMI is here to help you evaluate how your personal finances and future life fit into your exit plan. Let one of our advisors know if we can help you think about how to focus on business value and business income.
CCMI provides personalized fee-only financial planning and investment management services to business owners, professionals, individuals and families in San Diego and throughout the country. CCMI has a team of CERTIFIED FINANCIAL PLANNERTM professionals who act as fiduciaries, which means our clients’ interests always come first.
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