Factors that Affect a Valuation Multiple
As a business owner, you understand the importance of knowing the value of your company. A business valuation not only helps identify that value, but also identifies key risks of the business.
Key company risks often impact and help determine the valuation multiple applied in the business valuation. Increasing risks associated with a business decreases the multiple a potential buyer is willing to pay for the business. On the other hand, decreasing risks associated with future earnings will increase the multiple a buyer is willing to pay for your business.
By understanding the factors that increase and decrease your company’s valuation multiple, you as a business owner can focus on specific areas to help maximize the value. Below are some of the important factors that increase and decrease a business’s valuation multiple.
Factors Increasing your Valuation Multiple
Strong Management Team
A strong management team is much more attractive to a potential buyer than a company who is solely dependent on its owner. A company is successful by attracting, training, and retaining awesome individuals. Companies who have strong management teams in place tend to have a higher valuation multiple.
Market Industry Growth
Firms that operate in stable or rapidly growing industry sectors are more valuable. Industries such as healthcare, energy, and education have favorable growth prospects as there is a consistent demand for these products/services. For more information about specific industry sectors check out our blog on industry risks.
Despite the industry your firm operates in, the business value largely depends on the company’s growth and earnings potential. This factor is often one of the largest that influences a company’s valuation multiple. Many investors look for companies that are scalable and have high growth potential. While a plan for future growth helps the valuation multiple, a demonstrated historical growth with a clear plan for the future has a more positive impact on the valuation multiple.
Loyal customers create consistent income which generates the cash flow needed for regular operations. These recurring customers reduce the risk associated with future revenue generation. Long-term contracts with customers and renewable subscriptions help maximize your company’s valuation multiple.
Stable, Consistent Earnings
Stable, above industry average earnings increase the value of your company. The higher this valuation factor, the lower the risk that business earnings will decline unexpectedly.
Goodwill and Brand Recognition
Goodwill can go a long way in your business valuation. There are a variety of things you can do to increase goodwill and brand recognition. See our article on goodwill for more ideas.
Factors Decreasing Your Valuation Multiple
Dependence on Owner
Businesses who are overly dependent on the owner’s personal skills, abilities or contacts are less valuable. This is because the ability to transfer the skills, abilities or contracts into future cash flows with the new owner becomes questionable. This dependence is also known as “personal goodwill.” As such, it reduces the valuation multiple a potential buyer would be willing to pay for your business.
Customer and Supplier Concentration
Dependence on a few large customers or suppliers is very risky. If any customer is lost, the impact on business earnings can be drastic. For instance, if one customer makes up more than 80% of the revenues, future earnings are dependent on their purchases. Similarly, if a significant amount of your goods are from one key supplier and that supplier raises prices or can’t meet demand, revenue may be lost. Successful companies try to reduce their dependence on a few large customers and suppliers. If the risk of this factor is high it decreases your valuation multiple.
Product and Service Concentration
Having a very narrow product or service offering increases the risk of a company becoming obsolete. Successful businesses offer diverse products and services. Additionally, companies who stay up-to-date with technological advances and market trends are less risky. The higher this risk the lower the valuation multiple will be.
Volatility creates uncertainty leading to increased risk and a decreased valuation multiple. If your company’s earnings fluctuate significantly over time, potential buyers will place a lower valuation multiple to your business. Creating stable and increasing earnings over time is very valuable.
Peak Business Valuation enjoys working with small business owners to help maximize their company’s value. Through a business valuation we can help you identify risks associated with your business. Peak focuses on providing valuable information to help you grow, sell, or buy a company. We have worked with over 200 small businesses across the country. Questions are always welcome. Please reach out via email or phone call.Schedule Your Free Consultation Today!