Prove your worth: forget the stock market. The best way to build wealth is to invest in your own company. And now's the time to show the world what your business is made of

Entrepreneur,  July, 2003  by Mark Henricks

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While the wealth of the stock market exploded during the 1990s, the wealth of entrepreneurs fizzled. As the decade dawned, small firms held just over 59 percent of the $5.7 trillion in total value of U.S. businesses, according to a study by the SBA. By 2000, that share had fallen to percent as soaring stock valuations more than doubled big public valuations during the decade.

A lot has changed since then, and one of the changes is a switch in the relative performance of small and big companies. The $11 trillion in big-company value seen in 2000 had slumped 25 percent to $8.3 trillion by the middle of 2002, the latest period for which figures are available. Meanwhile, small-company value had fallen just 4 percent, to $4.1 trillion. What happened? "Big companies have been hurt by the stock market. Most small companies are not public. That's why the small-business share rose the last couple of years," says Kathryn Kobe, chief economist at Joel Popkin and Co., the Washington, DC, research firm that conducted the SBA study.

If you're thinking this means investing in your own company is smarter than investing in the stock market, you're

MOST-VALUE PLAYER: Even in a less-than-stellar economy, Robert LoCascio won value points for his ailing live-chat customer service firm by acquiring another company overseas. Can you do the same? right. Not only have small-company values held up better than the stock market, but right now, formerly scarce and costly items such as labor, facilities and equipment are plentiful and cheap. As a result, entrepreneurs like Dave Ratner, owner of Dave's Soda & Pet City, a pet-supply retailer in Agawam, Massachusetts, are finding that investing in their companies has the allure once restricted to Internet IPOs. Says Ratner, 51, "now's the time [entrepreneurs] can really build value in the company."

After more than a decade in which other forms of investment stole the limelight, business owners are only beginning to wake up to the hidden value in their own enterprises, adds Ray Manganelli, managing director at New York City management consulting firm Strategic Decisions Group. In his book, Solving the Corporate Value Enigma (Amacom), Manganelli says the average business creates only 60 percent of the value it is capable of creating.

Is that all bad? Not necessarily That means entrepreneurs may be able to increase the value of their companies by 40 percent simply by paying more attention to it. "It's a tremendous prize," Manganelli says. "And that prize can be the difference between profit and loss, between surviving and folding."

WHY BUILD WEALTH?

Dean Dinas, senior economist and director of the Center for Economic and Industry Research for the National Association of Certified Valuation Analysts (NACVA), a trade group for valuation professionals, estimates only about 5 percent of small businesses have had a formal valuation done by a qualified professional: One reason is entrepreneurs are too busy running their companies to be concerned about the value of those companies. Also, some don't think they need to build or measure the value of their companies unless they plan to sell.

There are, however, dozens of reasons to know and increase your company's value, none of which have anything to do with selling it. Before you set up a buy-and-sell agreement with a partner, decide how much life insurance to buy as part of an estate plan, create an employee stock ownership plan, or apply for an SBA loan, you must have a documented value for your business, Dinas says.

Many entrepreneurs rely on balance sheets, income statements or a gut feeling to estimate their companies' true value. But balance sheets and other financial statements used in the daily operation of a business are only the beginning when it comes to valuing a business. Intangibles such as customer relationships and human resources don't show up on balance sheets but are essential to accurate valuations.

VALUE 101

The price the company might sell for on the open market is the basic value benchmark. This can be determined by examining recent sales of comparable businesses. But no two businesses are the same, and selling prices vary according to what the buyer is looking for. Ratner had his business formally valued in anticipation of an expected bid by a large pet supplies retailer to buy it. The value came in at what he expected and at what the bigger firm typically paid for acquisitions--about five times annual earnings. The prospective buyer didn't offer a bid on the company after all, because Ratner's low-cost, out-of-the-way areas didn't match the bigger company s practice of locating in high-cost, high-traffic spots.

Expected future cash flow is the most common basic benchmark for setting value. So, typically you build value by increasing the amount of profit your business can be expected to generate in the future. That's how Robert LoCascio saved LivePerson Inc. from losing its listing on NASDAQ. LoCascio, founded the live-chat customer service company and took it public in 2000. Despite never earning profits, shares in the company traded as high as $8 before the Internet bubble burst. Then they fell as low as 7 cents, and delisting loomed.