The basics of monetizing your business
Monetization – our favorite word that no one understands. We have a saying that describes our clients’ feelings, “I don’t know what that is, but I want some.” The real concept of monetization is probably something you can relate to, especially if you own a business. As an owner, you have an amount of money tied up in the business and you would like to turn some or all that money into cash you can spend. Unfortunately, this is where it gets complicated. In order to monetize a business, first we must establish that a business has value.
If a business has $15 million of revenue and $12 million of expenses, that would leave $3 million of net income. The net income is the only amount of money that belongs to the owner. The good news is that the value of the business is not just limited to $3 million. For the concept of value, let’s assume the business has revenue over multiple years. In this case, we would be able to establish an idea of how much the net income is growing. Having a $3 million check for one year is nice, but an annual $3 million income that grows has real value. Think of it this way, how much would someone have to pay you to give up a growing income of $3 million? Would you accept $3 million? No one would accept that trade. By the second year, you would have lost money. What about $20 million? Now we are closer. Maybe some would take that deal, maybe some wouldn’t, but what we have done is given you some idea of the value of this specific business. The value is defined by the price a buyer is willing to pay and a seller is willing to accept.
Monetization can be the outright sale of a business to a third party for cash. In the example above, the business owner would accept a payment of $20 million and transfer the ownership of the business to the buyer. The outright sale of stock or assets of a business has its own complexities, but for our purposes it’s the most straightforward. For the business owner though, this solves only one issue regarding monetizing their assets. Many owners are emotionally tied to the business and its continued success. An outright sale removes the owner from all aspects of the business and the people there within. This can be unpalatable because it removes the owner from their comfort zone. While risk can be reduced, the owner’s anxiety is raised due to the lack of control. In this case, we need to explore other options that may meet the needs of the business owner.
Another common situation involves bringing in fresh eyes and feet to drive the business to higher levels – a partnership. Owners of a successful business are, quite often, presented with ideas and opportunities that can take their business to a whole other level. In the early days, maybe they would have jumped at an opportunity, but for many reasons they now pass. Passing on these potentially lucrative deals may not be in the best interest of the business and, in turn, the best interest of the largest shareholder. Bringing in a new partner might be just the shot in the arm the business needs; a fresh person that has the energy to take on new opportunities and the drive to work the hours it would take to make it a success. In this scenario, the owner would not sell the business outright. They would keep some level of ownership at a lower percentage. This can be a very lucrative option, if a partnership can be found with a partner that has both the ability to drive the business and the cash to buy into fifty percent of the value.
When transferring assets to an employee or family member, it can become complex if the individual cannot afford to buy the business. If the employee has money set aside to purchase the business from the owner, there is no complexity. The issue comes when the employee does not have the funds to purchase the business. This is one of the most complicated ways to monetize the value of a business because it involves debt financing. For many small business owners, this may be the first interaction with commercial lending. First, the institution that lends the money will use the future revenues of the business to pay back the loan, meaning there must be enough excess revenue to cover the payment. Most banking standards require a business to have enough excess to cover three times the monthly payment. Second, the lending institution is going to look for collateral, personal guarantees and detailed business financials. The lender will require the excess revenue to be adequate after the business owner leaves the business.
This brings up a common issue for most small businesses. The owner is often the driving force behind the revenue. As part of that monetization process, the business owner must work to promote management and other key employees, so the business can persist without the owner physically being there. If the owner has successfully transitioned his or her duties to others, the bank and lending institution can feel comfortable that the income will continue and the risk of not getting a return on their money is reduced.
Many of these issues come up after it is too late to address them. At RCG Valuation & Monetization, we offer many services to help business owners who find themselves in these scenarios and we encourage them to work on these issues as soon as possible. It’s never too early to start planning for a transition.
Scott Roelofs is the owner of RCG Valuation & Monetization.