Building Equity Value For Your IT Service Company</h1> <article> <h1>Building Equity Value For Your IT Service Company</h1> <p>MySolutionSpot Editor — Sat, 12 Jul 2008 03:39:43 GMT</p> <p>If you are just starting your company, the idea of equity value is probably not on your radar screen. If you have owned your company for 10+ years, it has probably occurred to you that you might want to sell your company and do some world travel and work on that golf game. In either case, if you are thinking about how to build equity value in your IT service company, there are some basics you need to know about. </p> <p>The first thing to know is that the real value of your company is not going to show up on your balance sheet. All service companies have this issue – law firms, consulting firms, and IT service companies included. Generally service companies have no major capital assets like manufacturing equipment or production facilities. </p> <p>Most don’t even have any significant inventory. Without assets the only way to build equity is to accumulate earnings in the company. But usually that is not a good idea because of the tax implications. As a result, service companies use a different approach to defining value. Usually this is done with the help of an outside accounting firm that specializes in company valuations (a “valuation” is different than an “evaluation” – experienced accountants get a lot of humor out of people asking for an evaluation). </p> <p>The accounting firm uses several methods to calculate the market value and then they usually summarize their process in a report and present a final number along with a range from high to low. This report can become the basis for pricing the stock of the company, for taking out a loan, for buying another company to mention a few possibilities. </p> <p>Company owners often don’t think about the value of their company until a critical need or opportunity arises. But then it is usually too late to do anything that will make a big difference. The informed owner, however, will think about this way ahead of time and will make minor adjustments that will have a huge impact on future company value and they will be ready to respond when an opportunity arises. </p> <p>There are many reasons for getting a formal valuation – some obvious and some less obvious: </p> <p>• selling your company </p> <p>• obtaining financing for expansion </p> <p>• bringing on a partner </p> <p>• adding new shareholders </p> <p>• setting up an employee stock option plan </p> <p>• acquiring another company (especially if stock is part of the deal) </p> <p>• merging with another company </p> <p>Key to all of these scenarios is knowing the equity value or market value of your company ahead of time - that is your ultimate bargaining chip. It is what you will trade or sell or use as collateral. If you have a low value, you won’t have much to bargain with. If you have a high value, you can get a lot and potentially give up very little. We will discuss more of the math of these concepts in future blog postings. So what specific actions can you take to build equity value? Before bringing an accounting firm in to do a valuation, what actions can you take to create the best results? </p> <p>Here is a very basic list of actions you can take: </p> <p>1. Maximize recurring revenues – this has much greater value than one-time revenues such as special projects and on-call support. </p> <p>2. Put your customers on formal service agreements that define recurring fees and special project fees. </p> <p>3. Customer agreements should include a term of service (such as 12 months) with automatic renewal if there are no changes. </p> <p>4. Distinguish owner base salary from bonuses and dividends. All forms of incentive pay need to be viewed as part of the profits of the company for analysis purposes. </p> <p>5. Create a business plan that emphasizes steady growth. Lumpy growth or no growth can have negative effects on valuation. </p> <p>6. Plan for growth to come from existing clients as well as from new clients. Ideally you should be getting about 60% of your growth from existing clients or you are leaving money on the table. </p> <p>7. Be sure that overheads and direct costs are not increasing faster than your revenue growth. </p> <p>If either of these are growing faster, it can be a “silent killer” for many companies. 8. Know how your business performance compares to industry benchmarks. This can carry a lot of weight in valuations. We will be providing more detail on these concepts in future blog posts. The key message here is to not wait until a situation arises that requires a valuation. The earlier you get started learning what affects valuation and taking steps to increase valuation the greater the benefit to you will be when a need does arise.</p> </article> </main></body></html>