One of the key elements that impacts the value of your company is the industry in which it operates. When business appraisers value your business, they do an in-depth review of the industry and risks associated with operating within the industry. The business valuation report highlights most of the research.
This industry risk assessment affects the discount and capitalization rates for your business and therefore influences the business value. Two businesses who look the same on paper can have very different values. If your business is in a growing industry, the valuation is likely to be higher. Whereas a business in a shrinking industry, will have a lower value. While the general economic situation is important, the industry in which your business competes has far more weight. Here are a few key risks that our analysts use to determine the industry outlook for your business.
A business valuation analysts will look at the historical financials in order to observe growth. Depending on the industry, an analyst will inquire about the seasonal and cyclical trends. Lastly, the development stage of the company will identify what to potentially expect in terms of growth moving forward. For instance, emerging industries grow faster but face greater uncertainty than mature industries. Strong, predictable growth companies generally have lower industry risk and thus a higher value.
Next, analysts look at the competitive threats to each business industry. This may include how consolidated or segmented the industry is. For instance, if large competitors dominate the industry, it may decrease your business value.
Supply Chain Risks
Business analysts also consider the negotiating power of each of the players in your supply chain. If your company is at the mercy of vendors and operates in an industry with few suppliers your value may be lower. While a company with higher bargaining power tends to be less risky and more valuable.
Barriers to Entry
Lastly, things such as capital investment, licensing requirements or unique know-how provide barriers to entry. Regulatory compliance and legal requirements can also drive up the cost of doing business in the subject industry and create barriers to entry. Furthermore, as technology rapidly advances analysts look at whether the industry and your business is staying competitive in the current market. The higher these barriers to entry the more valuable your business is.
Other risks considered include the strength of the management team, skill sets of key employees, the financial stability of the company, intellectual assets, among others.
Industry Risks Impact on Business Valuation
So how does industry-specific risk affect your company valuation? Once a business appraiser understands the subject industry, they can then evaluate various financial metrics. This industry-based risk adjustment is then factored into the valuation.
- Income Approach:
- Depending on the risk of the company’s industry compared to the overall market, the discount rate may be adjusted up or down. In addition, growth rates are also impacted as high growth companies climax and become steady. This adjusted growth rate can then be used for capitalization rates in various valuation methods.
- Market Approach:
- Some comparables may be eliminated based on the industry risk assessment. If two companies within an industry look the same on paper, it is probable that both do not have the same operating risks. As such, it is important to understand the risks associated with comparable companies.
These industry risks impact the value of a business is many subtle ways. Valuation analysts who take the time to thoroughly understand the subject company’s industry and where the business fits will provide a more accurate valuation.
Your business appraisal report should outline the industry and how your company fits into the competitive landscape. Through reading the report, you can gain a solid understanding of the industry risks, the company’s competitive advantage, and support for the conclusion of value.
Peak Business Valuation would love to help you understand your industry risks and business value. We provide fast and insightful business valuations. Questions are always welcome! Please reach out via email or through a phone call.