What Drives Company Value Lower and What’s the Fix?

There are numerous things that can destroy company value, especially in a business sale. Let’s talk about a few.

Poor Quality of Earnings

Poor quality of earnings is a very common theme we see in companies. Quality of earnings is the quality of your financials and how accurate they are in determining your true earnings, so the buyer can gauge the real earning potential of your company. This is important to the buyer because this reduces the purchase risk for the buyer, especially if they are using your company cash flows to finance the acquisition. For example, if you have inaccurate and missing records, or incorrect revenue recognition issues within the company, this may hurt company value.


Inefficient Business Model

An inefficient business model can turn off buyers quickly.  Buyers realize that it is going to cost them a pretty penny to buy a business, therefore they want to buy businesses that can support their own cash needs so they don’t have to continually put in additional money to support company growth.

Let me give you a few examples of how the business model can impact purchase price negatively in some instances.

  • If your company requires Constant Innovation because its products become obsolete quickly, that might reduce the purchase price.
  • If your company requires Significant Working Capital and/or Heavy Annual Capital Expenditures to support its growth this may turn off certain types of buyers too.

We often get calls from buyers for innovation light, working capital light and capex light businesses. This is because if the capital requirements are heavy, this will not only require the buyer to come additionally out of pocket or borrow more money, but this will also likely reduce the buyer’s rate of return on the acquisition, especially in the early years.


Company Performance

Most business owners realize that declining company performance is bad, but often many don’t realize how bad. Feast or famine revenues and profits increase uncertainty and therefore increase buyer risk, and as a result may reduce purchase price. So for example, if you have a business that has unpredictable revenues or declining margins and profits, this will likely not serve you well.


Products & Services

Products & Services also play an important role in company valuation. The more proprietary your products and the better your competitive advantage, the higher your potential company valuation. Conversely if you have a company with commoditized products, low margins or lower than industry margins, or if your company’s products and services are highly sensitive to pricing,  this creates an additional layer of risk for the buyer,  because they may not be able to pass on cost increases to customers without losing market share. As a result, they will demand a lower purchase price to compensate for the risk.


Margin Drain

Companies are laden with inefficiencies and this can cause dramatic margin drain in the underlying business. For example, these can be items like production bottlenecks, errors and  rework, and improper purchasing controls etc. These serve as great opportunities for an experienced buyer because they will likely buy your business on the basis of its cash flow, and if it is depressed due to these inefficiencies, the opportunistic buyer can take advantage of these inefficiencies and quickly plug the margin drain.  In other words they bought the business cheaply because you as the business owner were not focused on fixing the margin drain.  

So here’s what you need to do. Put on a value-focused lens. Many of these value destroyers can be remedied through smart planning well in advance of a future sale of your business. Not only will fixing these issues maximize the sale price of your business, but it will improve performance making you a better, more profitable and valuable company along the way.

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