Top 10 Drivers of Business Value
What drives the value of your business up or down? To answer this question, let's put on the only lens that matters. The lens of an incoming buyer or investor. For the buyer, it comes down to the basics. “Risk vs. Reward’. They will focus on the future growth potential of a business vs. the underlying risk. So, the formula to drive up your business value translates to this:
To increase sale value, a business owner needs to improve the growth trajectory and simultaneously reduce risk factors through preparation and alignment of key value drivers. Here are 10 drivers of value that every business owner should work on so they don’t leave money on the table when it is time to sell.
1. Sustainable & Growing Revenues, Profits and Cash Flow
Strong revenue and cash flow are prerequisites to selling a business for an optimal price. If the sales and cash flow are not reliable, it’s likely a business is not performing well and may be too risky for a buyer to consider. So what is the trick to get top dollar? Demonstrate clear top-line revenues, bottom-line profitability and strong cash flow before bringing a company to market. If your business has strong recurring revenue, this will likely drive up the price even higher.
2. Diversification: Customers, Suppliers, Products, Services & Industries
Diversification is fundamental to mitigating risk. This includes diversification of customers, suppliers, and products and it drives value by reducing operational risk.
- Customers: Diversifying the customer base would ideally result in no one client contributing more than 10% of total sales. The more heavily a business relies on one customer, the more vulnerable it is to folding completely in the long run.
- Suppliers: Finding multiple places to source materials and supplies is crucial to long term stability and makes operations more reliable in the buyer’s eyes. The last thing a buyer wants is a mission critical supplier who is difficult to replace.
- Products, Services & Industries: Having revenue from multiple products and services in diverse industries goes a long way in reducing risk in the buyer’s view. Your company has one more leg to stand on if there is an industry downturn or if one product becomes obsolete. Products and services catering to multiple industries typically increase the stability of a business and add long-term value.
3. High-Quality Financials
Keep all financial information and records well documented—these help prove value. Clear, accurate, and consistent financial information provides the foundation for displaying reliable revenue, cash flow, and profitability. In the Merger & Acquisition business, we refer to this as “Quality of Earnings”, i.e the ability of reported earnings to predict a company's future earnings. It is the only reliable way to assess how "repeatable, controllable and bankable" your company‘s earnings are, along with other variables. If your financial data is unreliable, this will reduce buyer confidence and henceforth the chances of the deal getting done at the targeted price, if it gets done at all.
4. Growth Potential
While buyers will carefully scrutinize a company's past financials, what they are really buying is the promise of tomorrow. Demonstrating growth potential is critical to demonstrating value. Having a well thought out and realistic growth plan is paramount to convincing buyers that they will not only recoup their investment but make significant profits down the line. Without this piece of the puzzle, it would be very difficult to maximize your valuation.
Growth plans should consider several avenues, including which products or services have the biggest profit margins? How can we expand those products? Are there new markets in our industry? How can we tap them? What will the future demand for our products be, and how can we take advantage of those trends? A growth plan serves to convince a buyer that the multiplier they’re paying for a company is worth it, so prepare in advance how to answer these questions.
5. Strong Management and Employees
Because many business owners are practically unemployable or have a short time horizon before they want to move to the next chapter of their lives, it is really important that key managers have the experience, motivation, and incentives to stick around and grow the company. This is another way an owner reduces risk for the buyer in an acquisition. Retention of valuable employees is key to a smooth ownership transition, and systems like long-term incentives should already be in place before a sale so buyers will not have to worry about the workforce.
6. Systems and Processes
Business processes and the systems within an organization should be clear, structured, and documented. This mitigates risk for the buyer because procedures are explicit and not only offer guidance to employees but are valuable because they can create operating efficiencies that can directly impact operating costs and the underlying profits. Examples of systems include: production processes, personnel processes like recruitment and training, customer acquisition systems, quality assurance and control mechanisms, communication structures for employees and clients, among others.
7. Equipment and Facilities
Before bringing in a buyer, ensure that facilities and equipment are well organized, up-to-date, and clean so they contribute to the company value. Outdated and ill-maintained equipment and facilities will often reduce purchase price because the buyer will most likely have to invest additional funds to get things back to normal. This scenario is called “Deferred Maintenance”. If you are in this position, get the house in order before entering the market or it will cost you.
Depth and breadth of strong relationships in your business and industry sphere can lower risk and increase value. These relationships are evidence of the ‘soft’ success of the business, whereas ‘hard’ success is demonstrated by financials and operating history. Relationships with customers over several years, referrals, and strong reputation are all valuable because they suggest future business transactions and a lower-risk investment.
9. Barriers to Entry
Barriers to entry are all about positioning your business so that it is hard for competitors to enter your space and take away your market share. For a business to be successful it must be different from competitors and play to its strengths. That is also a prerequisite to surviving as a company, but you should make the position stronger by securing and documenting those features that make a company unique. These include getting patents, filing copyrights, protecting intellectual property, renewing hard to get licenses, securing distribution rights, documenting and updating proprietary information or anything else that contributes to your company’s special position.
10. Loose Ends
Loose ends can typically be boiled down to contracts, and a lack of them. Companies with missing or non-existent contracts are riskier investments and will receive lower valuations. Important contracts that generally can help improve or in some cases sustain sale price include items such as key leases, employment contracts with key employees, customer agreements, strategic partnerships and strong contracts with suppliers. Get these agreements in order not only in preparation for a sale but for your own peace of mind.
Getting a company properly ready for sale can take years, especially if you want to harvest maximum value for your life’s work. By focusing on the key value drivers of your business not only will you improve your valuation, you will have a smarter, more efficient, and profitable company along the way.
So where do you stand today?
Are you maximizing your company's growth and valuation potential?
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