"CFOs are the people that should be the custodians of value in a company."
This basic premise underscores the purpose and meaning behind Reed Phillips' and Charles Slack's hypothesis that finance chiefs, perhaps better than anyone in the organization, are equipped to both value the company and set the path to creating future value.
This analysis sets the stage for their six-part series on CFO.com.
- Part 1: Are You Your Company’s Chief Value Creation Officer?
- Part 2: How Well Do You Understand Your Company’s Value Drivers?
- Part 3: Finding the Multiples Essential to Determining Your Company’s Value
- Part 4: Unlocking New Value for Your Company
- Part 5: Putting Value at the Center of Your Strategic Planning
- Part 6: A Q&A with Reed Phillips and Charles Slack
Phillips and Slack joined CFO for a post-series Q&A where the co-authors share what inspired them to tackle the material, their experience equipping CFOs to take on this leadership role, and how it impacts the C-suite dynamic.
This interview has been edited for length and clarity.
ANDY BURT: How did the idea come together to write a book about company valuation?
REED PHILLIPS: The idea for the book really came about because I've been working with owners of mid-sized companies for about 30 years. And what I primarily do is help them understand what their businesses are worth, and then how to achieve that value in a transaction. We [Oaklins DeSilva & Phillips] are an M&A investment bank, and we're typically selling companies or buying companies on behalf of clients. We know how to value businesses.
But what I found is most of the owners, particularly entrepreneurs, actually don't have a good grasp at all on what their businesses are worth. We'll say, "What do you think your company's worth? And why?" And the answers are across the board.
They'll say, "I was at an industry conference six weeks ago, and I heard this other company that's kind of like mine sold for 12 times EBITDA, so that's probably what my business is worth." And that couldn't be more incorrect.
CHARLES SLACK: I think one of the key things is the idea that valuation isn't just about "selling." And I think so many owners tend to think of it as that sort of, "end of the rainbow" day, and they don't really need to think about valuation until that time in the end. They have this payoff in the back of their head based on something they heard.
But what I loved so much about Reed's idea, and one of the things that we explored in the book at some length, is your valuation is really central to your ability to plan near-, mid-, and long-term.
PHILLIPS: Our thought, as Charlie and I worked on the idea and progressed, was that companies needed a way to value their businesses once a year. And then they could compare it with prior years.
When similar companies get sold, we stack them up against each other, almost like a height chart. But you're arguing that is not the best way to determine value prior to sale.
PHILLIPS: You do see the company's worth in those comparisons, but you don't know why. And that's part of what we try to illuminate. And we do that through value drivers, which are the factors that really make a business valuable.
There are between eight and 12 value drivers you should isolate and then evaluate. Those are the things that are qualitative rather than quantitative. Most valuation methodologies only focus on quantitative analysis. We, of course, use numbers and formulas, but we're adding a whole new component to valuation. The reason they don't get used is because most valuations are done by outside third parties, but third parties can't possibly understand the business the way insiders do. So they rely only on quantitative analysis.
I think one of the key things is this idea that valuation isn't just about "selling." — Charles Slack, business and financial writer
SLACK: Even if you have an idea of what companies in your industry are "like yours," you actually have good information internally based on your unique characteristics. That's the idea behind the value drivers.
How do CFOs and owners compare when it comes to valuing the company?
PHILLIPS: In my experience, the owners and CEOs overvalue their company and the CFOs are more likely to more realistically value the company — maybe even undervalue it — just because that's the nature of being a CFO. CFOs tend to be more conservative. A lot of times, the owner will just be pushing for all the reasons why the company is worth more, maybe because his friend sold his business for 18 times EBITDA, that sort of thing. And the CFO will be a little bit more grounded and look at quantitative measures.
That's why we were excited about writing this series for CFO. Because CFOs are the people that should be the custodians of value in a company. They know all the numbers and typically oversee the budget and the strategic plan. They're naturally positioned to do this.
This naturally leads to the question — how does the CFO communicate with the owner or CEO to make sure they're on the same page for valuation?
PHILLIPS: That reminds me of my very first internship. I was doing strategic planning for a company called Carolina Power and Light. The department I was in spent time gathering information and determining what the company needed to grow that business. And I went around and interviewed everybody, and I worked with the head of planning, and we put together a strategy paper, and we laid it all out. And then we handed it to the head of our department. And he basically ripped up our plan and said, "That's not what I want. I want these two supercomputers, and, this and that," etc. He had his own plan in mind.
In my experience, the owners and CEOs overvalue their company and the CFOs are more likely to more realistically value the company — maybe even undervalue it. — Reed Phillips, CEO of Oaklins DeSilva & Phillips
Owners and CEOs may continue to be more optimistic, but hopefully, CFOs will be able to have a dialogue with them that's constructive. It might be more like, "we have figured out some of the areas where we can improve the business that will create even more value than what we currently have created. We think this is what the value is now, but we think we can get to a higher value. And here's what we need to do." And you just lay out the plan.
And hopefully, it becomes something everyone agrees on in terms of taking action steps to increase value.
SLACK: We think that's one of the advantages of undergoing the quick value process. And the more you do that, the more of a defensible case you have for the valuation you've determined, and when you present that to the CEO or owner, buy-in is more likely.
A reasonable value has got to be the objective of the exercise. Going into this, there has to be a certain level of commitment by the owner to gain an accurate picture.
PHILLIPS: You know why the value is where it is, and the CFO is going to be armed with the answers because they've done the work. They aren't just pulling numbers out from conversations they've had with other CEOs about how businesses are trading. You're looking specifically at your own business.
You're still comparing it with other businesses, but you're not just assuming that your business is like all those other businesses. You're determining what the differences are and what impact that has on the value, and how you might improve the value by focusing on those value drivers.
How does this value driver analysis help CFOs in their career goals?
PHILLIPS: I see CFOs who tried to just stay on the box as a CFO, and they just kind of do what they think the CFO is supposed to do. But I think the best CFOs are the ones who not only want to do that, but they want to be more involved in the management of the business and improving the business, and creating more value.
SLACK: I think that's right. And I think CFOs — and everybody who participates in this value driver process — not only comes to understand the business at a different level ... that they didn't have before, but can be seen as contributing to the increasing value of the business. That of course is an extremely valuable thing, not just from the perspective of the business, but from the personal perspective every professional seeks.
Reed Phillips is CEO of mid-market M&A firm Oaklins DeSilva & Phillips, and Charles Slack is a business and financial writer. They are the co-authors of the book, QuickValue: Discover Your Value and Empower Your Business in Three Easy Steps.