Key Value Drivers in Business Valuation
The following are several key value drivers considered in business valuation that can be utilized in your business today. Consider each of these value drivers throughout the life of your business and understand how they impact the value when selling your business.
The primary value drivers of your business are reflected in the past and future financial performance of your company.
- Accurate and up-to-date information is critical. Have you just done the minimum for financial reporting, or do you have thoroughly prepared financials reviewed by a professional CPA? Many business owners self-prepare financial statements rather than spending time with a CPA. With the assistance of a CPA and other finance/accounting professionals, you will have more accurate records and be able to better identify strengths and weaknesses in your business.
2. Key Performance Indicators (KPI)
- KPIs measure a company’s performance and can be used to compare to the industry and to your competitors. This gives a good indication of value and the efficiency and profitability of the business’s operations. Revenue growth is a KPI that many buyers will look at when analyzing your business. If you are not growing, you are dying and no one pays a premium for a dying business.
- Growth trends are of high importance in the valuation. Does your business show a pattern of growth or decline? If there is a decline, are there good reasons for the decline? Detailing these reasons is essential. Valuation analysts look at whether you are growing faster or slower than the competition, and historical trends may be used to determine how the business will perform in an economic recession verse an economic boom.
- Lastly, understanding your industry’s target margins is key to exit planning, as they are the main drivers of your company’s valuation. Many business owners make a great mistake by focusing only on their revenue while neglecting their margins. One should continuously track their company’s margins and benchmark them against comparable companies. Strong business owners understand the importance of tracking and benchmarking their gross margin, EBITDA margin, net income margin, and cash flow margins in order to drive a premium valuation. Don’t let your margins bring down your valuation.
Buyers often want to see an experienced management team, who are committed to the success of the business despite ownership changes. A few questions to ask: What is the experience level of the current management team? How long have they been with the business? A responsible buyer will look for opportunities where the current workforce, especially management, will remain in place, following the current owner’s exit from the business. Having key employee contracts, non-compete agreements, and loyal, dedicated staff will be highly valuable to a prospective buyer and thus reflected in a business valuation.
A company with a formal succession plan that has identified leaders from within has a stronger position to negotiate a higher price. For many businesses, the management team consists of only a few people or even just one person. To build a more valuable business, the management of an organization should include people with a variety of skills who can successfully run the business after the owner’s departure, and, collectively, do the majority of what the owner does today. The stronger the management team, the higher the value of the business tends to be.
Highly competitive market segments tend to suppress prices while fragmented markets with little competition tend to drive premium prices. Does your company compete in a clearly defined market niche with strong barriers to entry? Or, have your products or services become a commodity that is becoming more difficult to defend? It pays to be ahead of the immediate competition and/or to have a strategy to buyout the competition. Being a high-profile leader with brand recognition, service/product reliability, high customer satisfaction, and large market share is very attractive to buyers.
Intangible and Proprietary Assets
Intangible and proprietary assets allow your company to stand out from other competitors looking to sell. The value and price of the business increases if proprietary assets such as patents are sold along with the business. These assets are often valued individually in the business valuation. Consider whether your company has developed a unique application, tool, or technology and if so, does it give you a competitive advantage. Your processes may be better or more efficient than your competitors allowing you to achieve above average margins. Maybe you have superior intellectual property, software or a brand that is not easily replicated and provides high barriers to entry. This proprietary innovation or intellectual property can be positioned as a key value driver for your business. Technologies or processes do not have to be patented to carry value but privacy and confidentiality must be maintained. It is critical that non-compete and confidentiality agreements be strictly adhered to before and after a transfer of ownership. Value creation comes in many forms and sometimes it is not just about your revenue.
A diverse customer base helps to defend a company from loss of customers due to transition and loyalty to ownership. No single client should account for more than 10% of total sales. Repeat business and long-term contracts demonstrate loyal customers who continually require the company’s services and ultimately drive up the value. Should the majority of your company’s revenues come from a few customers, change of ownership may have an adverse impact and a discount will be applied to a business valuation due to lack of uncertainty and stability. This also goes for the company’s products or services. Relying too heavily on one product and service increases the risk of that product or service becoming obsolete or unnecessary.
There are many value drivers found within any small business that influence the business valuation. Each of these is examined on a case-by-case basis, with the assistance of a professional valuation consultant. As a business owner, take a close look at your operations to uncover some of the hidden gems and unique benefits your business has to offer future buyers. The primary drivers will be reflected in your company’s past and future financial performance, but the intangible value drivers can enhance a buyer’s perceived value of your business leading to a higher purchase price. Through your day-to-day operations, you can implement a system to increase your value and reap a higher financial return when you sell.
We at Peak Business Valuation work with a variety of businesses to help identify ways to increase their value. Even if you have not thought about selling your business or purchasing a business, it is never too early to start planning. The first step in that process is a business valuation, which we are happy to provide you with. We welcome any questions you may have. Feel free to reach out by email or through a phone call.Schedule Your Free Consultation Today!