I was hanging around in a toy store with my three kids, looking to buy something for them.
My son was looking at Matchbox (a UK-based toy company started in 1953) cars and was thinking about which one he should get. He was oscillating between two cars. He was confused because although both the cars were priced the same, one of them was slightly bigger and more attractive than the other one. "Baba, they are the same price! I like the blue one, but the purple one has larger wheels and is more stylish. Which one should I take?"
Meanwhile, my youngest daughter chose a puzzle and started comparing her choice with her brother's. Her dilemma was that a puzzle can be solved in one evening, whereas matchbox cars can be played with every day.
On another end, my eldest daughter was thinking of buying a Lego set, but then I convinced her to take a storybook, which is actually cheaper but much worthier than the toys. Considering her age, I thought she should focus on reading books rather than playing with toys.
But now the question is – am I being fair to them or am I being biased towards one choice? How should my son choose which car to pick or how should my youngest compare the options in front of her?
These dilemmas and questions triggered a thought in me - if choosing a simple toy can be this complex, then what about the valuation process of a family-owned business where decisions like constructing a buy-sell agreement during divorce proceedings, preparing for succession, selling the business, or even seeking outside investors depends on the valuation of the company.
Let's compare a business with my children's toys. Imagine a family-owned business is distributed among three successors – one gets the business copyright or the idea, one gets the rental infrastructure and the other gets some sellable property.
Here I would compare the business name or the idea with my eldest one's book - which might look less interesting, but in the long run she can invest and earn more with the knowledge she receives.
Then my son who picked the cars can be compared to the rental establishments - if he plays with the cars he will be satisfied and if not, he will not get anything. Similar to rentable property - if rented the owner will get money and if not, he will not get anything in return.
And lastly my youngest daughter's puzzle is the least interesting one, which is a one-time profit thing - once she solves it, she is done with it, and will get nothing else from the puzzle. Just like a one-time sellable property - once sold, you get money for that one time.
That's why proper valuation is very important for stakeholders and investors, especially in a family-owned business.
While public companies disclose their financial information on regular intervals, family businesses may go years without even calculating the true value of their company. Private companies don't need to know the exact value of their business every day, but they do need to have a method for calculating that value in order to monitor the business performance, plan for succession, interact with external stakeholders, and assist directors in determining whether they are currently adding value or destroying it.
Now, the proper valuation of a particular business requires certain organizational structures to be in place for a number of years, and then also the records need to be checked to monitor how these structures are doing.
Family businesses that have not taken steps to determine or protect the value of their business may find themselves in trouble. Because one day or another, valuation will have to be checked, and if it's not monitored regularly, at one point they will be facing a situation where they have to evaluate a lot of records and numbers in a very short time - almost like finishing a huge syllabus just before the exam. This will eventually affect the stakeholder's decisions - like my children who were struggling to decide which toy (in this case, which parts of the business) is better and more profitable.
Bangladesh's industrialisation is backed by a number of family-owned businesses. Identifying and streamlining the valuations in this sector is increasingly becoming important, considering the fact that family businesses contribute a major percentage of the country's GDP. But the big question is – do these family-owned businesses really know their worth?
Three valuation methods for family-owned businesses
There are numerous valuation methods and a handful of these are frequently used for evaluating a family business. One can choose the approach that is best for their organisation and circumstances, with assistance from a valuation analyst.
The strategy most frequently utilised for established enterprises with a track record of steady profits is capitalisation of future maintainable earnings. It focuses on valuing multiple aspects of the company's sustainably growing earnings, which includes elements like earnings consistency, risk assessment, and market expansion.
Finding a suitable method can also be challenging for family businesses, which can cause conflict between stakeholders. For example, take the discounted cash flow (DCF) valuation method.
This method is used to estimate the value of an investment based on its expected future cash flows. DCF analysis attempts to figure out the value of an investment today, based on projections of how much money it will generate in the future. This influences the investor's decision-making such as acquiring a company or buying a stock, and for business owners and managers looking to make capital budgeting or operating expenditures decisions.
This strategy works well for companies with steady cash flows over an extended period of time. The fact that it can be challenging to create long-term budgets and extrapolate cash flow requirements into the future, necessitating a variety of assumptions that may be challenging to justify with facts, is one of the method's obvious disadvantages for some firms.
Tangible asset valuation is another method where a company's physical property like working capital, land, buildings, machinery, and equipment - determines its economic value. This approach, which disregards intangibles like goodwill, is particularly helpful for some service or marketing-related enterprises with considerable investments in plants and equipment.
Look out for pitfalls
Several factors might reduce the value of a family business. These pitfalls can be divided into two categories: management concerns and operational issues.
On the management side, I have observed businesses lose value as a result of a formal board's absence, directors' lack of succession planning, which exposes the company to the loss of key employees, the improper appointment of family members to senior positions, and insufficient family governance structures – such as a family council and family constitution.
And on the operational side, the valuation process might be harmed by a lack of corporate strategy, established systems and procedures, and strong financial reporting.
Creating a system for a company's valuation goes beyond common sense - it may be quite useful when interacting with lenders and outside stakeholders. In order to convey this value to outsiders who are unfamiliar with the businesses, it can be helpful to be able to quickly assess the health of an organisation, its future course, and the significance of that plan.
And maybe one day by choosing the proper valuation methods and checking the pros and cons of them, my children will also be able to decide the best thing for them - a toy car, a puzzle or a book.
The author is the Managing Director of Miyako Appliance Limited, Bangladesh and the first Doctor of Business Administration from IBA, University of Dhaka. He can be reached at [email protected]