“He uses statistics as a drunken man uses lamp-posts ... for support rather than illumination.” -- Andrew Lang
After the first Three Horsemen of the Apocalypse have stomped through the rose garden, it’s a bit unnerving to recall that there’s one more untamed stallion crossing the yard, the trailing companion of Pestilence, War and Famine that have already intercepted our plans for world domination.
As we’ve seen, the first Three Horsemen signify the destructive forces that can wreak havoc in our businesses from our failure to pay attention to the principles of business finance. Pestilence represents the sudden and unexpected lack of cash that often appears just before payroll is due. It is War when we struggle to grow because of a lack of financial resources. Famine lays waste to our plans when there is a lack of access to outside financing.
Yes, this is a dramatic re-enactment of the apocalyptic metaphor, but it will serve its purpose if it incites you to implement sound principles of business finance, the only effective weapon to defeat these forces. In future columns, we will consider very specific steps to achieve command and control over your financial performance so that these forces don’t get a foothold in your business.
The Pale Horse is the final member of the Four Horsemen and brings what may be the most destructive force of them all … the recognition that you haven’t created much value in your business after all. The Pale Horse appears when you go to sell or otherwise transfer your ownership interest and, too late, realize your many years of hard work and dedication have not resulted in the value you expected. This is the Death that sits astride the Pale Horse.
There’s a pervasive sense among many businessmen that value creation is synonymous with profitability or revenue size or market share or some simple metric that is easily measurable. Most business owners are easy prey for seat-of-the-pants yardsticks to measure the value of their company. They’re quick to embrace a multiple of EBITDA or revenue or net income as a handy measure of value without taking into account any of the additional variables that really apply.
More importantly, most business owners pay little attention along the way to whether they’re actually creating or destroying value each year. They ignore their return on assets, rarely compare it to their cost of capital and never evaluate whether the return on the assets in which they’ve invested exceeds the cost to acquire them. They have unrealistic expectations founded on scuttlebutt, Internet chatter and a perverse resistance to address financial reality.
Valuation is a complex subject, certainly more art than science, and I’ve written about it regularly in this column. You don’t need to spend a lot of money every year for a formal valuation, but you should become familiar with the industry and performance metrics that are used by M&A professionals. There are lawyers, accountants, valuation experts and transaction specialists in this group who regularly study industry standards and performance metrics that apply to the sale or other transition of a business.
The Pale Horse rears its head when a business owner suddenly finds himself scrambling for a financial or valuation expert to wrench an acceptable value from the clutches of poor historical performance. Be sure you’re on top of this value creation process so you understand – every year – if you’re creating or destroying value so that you don’t see the shadow of the Pale Horse crossing your vision.