How Does Reliance on an Owner or Other Individual Impact Business Valuations?
Business valuations are vital to the sale of companies. An accurate and high valuation allows owners to market at a premium price, while an undervalued company is unlikely to attract much interest.
Our commercial litigation team act in a variety of commercial; business, shareholder and investor related disputes, nationally. In this context it can be important to consider valuation as an important (often critically important) aspect of any dispute. Understanding how a valuation might proceed goes towards what an outcome might ultimately look like. This in turn impacts the cost; benefit analysis involved in any (all) litigation.
A crucial consideration when valuing a company is how strongly it attaches to its owner or specific individuals. An over-reliance on a particular person for the business’s smooth running can impact saleability and value, as purchasers prefer to invest in companies that can run independently of one person.
This blog post explains owner dependence, how this impacts valuations, and how to reduce it to improve value. If you are involved in a commercial dispute and are considering valuation of the business or your shares, keep in mind that this is only one aspect of many that will impact your prospects of success and the likely outcomes for you. For further information on this and to consider your dispute further, contact a member of our commercial litigation team at Helix Law and we will be happy to help you.
What Is Owner Dependence?
Owner dependence means the extent to which a company relies on its owner, proprietor or key personnel to function correctly. In owner-dependent businesses, day-to-day tasks, such as operations and customer service, are primarily carried out by one individual.
For example, the owner of an estate agent’s practice might be the only point of contact for customers while making all the business decisions and managing financial accounts. Running a business this way can seem cost-effective in the short term.
However, if this person suddenly cannot fulfil these roles, for example, due to sickness or leaves, the operational disruptions and knock-on effects could be substantial and at worst it can suck much of the value out of the business.
How Owner Dependence Impacts Business Valuation
A business may obtain a valuation for many reasons, but one of the most common is an intention to sell. An expert valuer will consider various factors, including its assets, liabilities, and revenue. Another critical consideration is how the organisation operates and is managed, which includes assessing if it can maintain its profitability without the owner’s involvement.
A company tied too closely to its proprietor won’t be as attractive as an investment. Upon the relevant individual exiting the business, the new buyer will likely need to carry out an operational overhaul to get things running smoothly again. The purchase, therefore, carries significant risk, which is reflected in a lower valuation and often a discounted sale price.
Why Buyers Are Cautious of Owner-Centric Businesses
Purchasers want an investment that will work well for them, meaning minimal disruption, maximum return, and the best chances of long-term success. Owner-centric businesses are concerning to potential buyers because:
- They often don’t have the appropriate systems for the organisation to adapt. Therefore, the company will likely have more difficulty expanding.
- Practically, purchasing an owner-centric business can also lead to extended due diligence and negotiations, which is off putting for some.
- If only one person holds all the essential knowledge about the company, the transfer of this information could result in gaps or ambiguities.
- Clients often develop close relationships with individuals heavily tied to the business. Customers may not want to continue their professional relationship with new personnel when that individual leaves.
- A new buyer may struggle to separate the brand’s identity from the existing owner, making growth more challenging.
Owner Dependence and Its Effect on Sale Price
There are several effects this type of business can have on value:
Price
The most obvious impact of owner dependence is on sale price. Buyers will only offer a premium for companies they are confident will continue running smoothly after the takeover. The risks of uncertainty, instability, and lack of growth mean they often expect a lower price to account for the additional funds they’ll spend on adapting operations.
Marketability
Marketing a business like this is usually more challenging, as investors may not have confidence in the purchase from the outset. Initial interest can quickly turn into potential buyers pulling out. Marketing a company for sale can be expensive, especially if it sits without interest for an extended period.
Structure of the Deal
The sale contracts will likely look different for an owner-centric business, as the buyer will want to mitigate risk. For example, an investor might require the existing proprietor to stay involved in the company during a transitional period to facilitate a smooth handover.
Parties may also agree to include an “earn out” clause, which makes part of the sale price dependent upon future performance. Agreeing these types of arrangements can be a complex and costly procedure.
Transition Period
The existing owner must often remain involved in the company after the sale. This transition can be uncertain, as the owner may not be willing or able to stay engaged for a sufficient period.
Transitioning Client Relationships for a Successful Sale
A crucial consideration for a company to sustain its growth following a purchase is transitioning client relationships. Customers who are used to having a direct relationship with a specific person and aren’t warned about new management may decide to take their business elsewhere. Carefully managing this transition is, therefore, vital.
To maximise customer retention, businesses should gradually shift client relationships and communications to the new team before the sale. It allows clients to become familiar with new management while feeling assured by the existing owner’s involvement. This approach helps maintain consumer trust and prevents them from feeling blindsided post-takeover.
Companies should consider appointing multiple new points of contact who can introduce themselves to clients and create a dedicated team to manage the transition.
Steps to Reduce Owner Reliance and Increase Value
To maximise business value, owners should consider taking the following steps:
- Delegate tasks: Delegating essential responsibilities not only eases the burden on the individual but also means the company can function without their involvement. The owner can do this gradually to allow time to adapt.
- Keep documentation: Retaining accurate and detailed records of processes allows a new investor to take over with minimal disruption easily.
- Create a leadership team: Appointing other individuals to head up key parts of the organisation improves its longevity and motivates employees to stay longer.
- Build brand independence: Distinguishing the brand from the individual means the company can continue to succeed once that person leaves. Rebranding and raising awareness of the other team members are good examples of how to do this.
- Nurture client relationships: Change can feel daunting for customers, so it’s vital to provide advance reassurance that the company will continue to serve their interests post-sale.
Frequently Asked Questions
What are the factors influencing business valuation?
Various factors influence a business’s valuation, including its assets, liabilities, revenue, profit margins, market position, and growth potential. A company’s value also depends on its customer base and competitive advantages. All these considerations are impacted by whether the company is owner-centric and if it can operate independently of a specific individual.
Final Thoughts
In any litigation or dispute you’re going to want to consider how best to position yourself for the best possible outcome. In simple terms that will include either maximising or minimising the value of your shares or the business depending on whether you are the buyer or seller in the transaction. Owner dependence can significantly impact a company’s value, sale price, and marketability. A business too closely tied to its owner brings uncertainty for buyers, who worry about investing further resources to maintain operations post-sale. They also risk losing clients, struggling with brand identity, and a lack of knowledge once the existing owner leaves. Therefore, investors face extended negotiations and potentially complex sale contracts, leading to lower offers.
This is an area where we typically instruct accountant valuers to assist us and our clients with a detailed briefing and understanding of the above factors important in helping maximise or minimise valuations depending on what we’re trying to achieve.
Organisations can improve their value by taking specific steps to reduce owner reliance. Owners can position their company as a more attractive investment by delegating tasks, documenting processes, developing a leadership team, and transitioning client relationships. Ensuring the business can operate smoothly without the owner increases its value and appeal to prospective buyers, improving the chances of a successful sale.
If you are a shareholder or partner in a business where there is currently a dispute, and you are considering valuation and other steps to exit, contact our commercial litigation team and our solicitors will be happy to help you navigate the best possible approach to improve your position overall. Whether preparing for a valuation on advantageous terms or taking other steps to position you in the dispute, our team are specialists experienced in this type of litigation and act in disputes of this type across the country. We will be happy to guide you through your best next steps. Contact Helix Law today for more information.
