Service-Firm Values Mostly In Personnel

The most valuable asset in most entrepreneurs’ portfolios is the enterprise they’ve created. But it’s not always easy to convert that asset into cold, hard cash.

Q. I’ve built a successful business that provides marketing services to other firms. Most of my personal wealth is tied up in the corporation. I followed your suggestions for establishing a value for my firm, but my accountant says I may be too optimistic. He claims service firms are generally worth less than similar size manufacturing or trade businesses. Is that true?

A. Unfortunately, service businesses, by and large, are less valuable in the market than businesses that make products or merchandise goods and services. This is primarily due to the fact that your firm’s principal assets go home every night at quitting time.

Unless your firm employs extensive, expensive technology to facilitate the process by which your employees convey value to your clients, the majority of the true worth of your company consists of you and the employees who work for you. Therefore, a potential buyer of your business is not going to pay you very much for the right to hire people he might be able to otherwise attract in the open market at no up-front cost.

Indeed, your key employees might very well decide to start their own business when you decide to cash it in. (Let’s hope they don’t get the entrepreneurial itch before you decide to call it quits. My ol’ uncle Ollie claims that “every bartender is the saloon owner’s next new competitor.”)

The unique talents you bring to your enterprise, the personal contacts you have with clients, your reputation and your industriousness are intangible and can’t be sold to another aspiring, entrepreneur. Worst case, your business is worth the furniture, computers and real estate that support your present employees. And these tangibles can easily be purchased - at no premium - from sources other than you.

Now the good news. There are some things that you can do to build the intangible, marketable “goodwill” in your business. As the value of your goodwill increases so will the price that you can command from a potential buyer.

First, try to grow your business to a size that will be difficult for someone else to replicate. Proprietary operating systems and procedures, computer software, trademarks and copyrights, and brand names all will add unique value to your firm.

Contractual agreements with your most important customers can be worthwhile assets too, providing your clients don’t demand an “escape clause” that can be triggered in the event of your departure. Employment contracts with key personnel can also help, although, to be enforceable, they cannot be too restrictive.

It’s also possible to sell ownership interests to your key employees well in advance of any significant move on your part. Not only will employee equity involvement increase your firm’s present productivity, but it will also greatly facilitate their purchase of your majority interest when you decide it’s time to move on, whether it’s retirement that beckons or a new frontier. (They will probably be willing to pay more for your firm than would someone who is not familiar with the business. Many times, owneremployees will pay a premium to gain control and to obviate the possible need to find another job when a new owner takes over.)

Don’t overlook the possibility of an ESOP (a tax-advantaged employee stock ownership plan which was described in an earlier column).

When the time comes, you might also want to explore the possibility of selling out to a “roll-up” acquirer, a new type of national service firm that has emerged during the past decade. These acquirers employ “platform investing” or “leveraged buildup” techniques to aggregate and “roll up” small, local or regional service companies into large, profitable enterprises with national or super-regional presence.

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