18 Feb Focus on Value Drivers to Maximize Business Value
The day will come when you want out. Given all your hard work and sacrifice, you deserve a big pay day. So, why not set yourself up today for that to happen?
As it turns out, buyers have a lot in common. Below is a list of characteristics that, when present in a business, entice buyers to pay more. Conversely, a lack of these characteristics detracts from the price received. These “value drivers” are listed in rough order of importance.
- Growth: Revenue and profit growth is the number one driver of value. Establish a pattern of growth and you will establish a substantial premium for your business. Of importance as well is rate of growth relative to that of the overall economy and, more particularly, of the industry in which the company participates.
- Profit and Profit Margins: Buyers buy businesses to make money. The higher the established profit, the more the buyer can and will pay to obtain those profits for his or her benefit. Profit margins are important as well. Are they higher than the industry averages? Gross and operating profit margins that consistently exceed industry averages will command higher values.
- Customers: Diversification of customers and customer tenure, loyalty and credit worthiness are important considerations when valuing a business. What would the impact on the company be if the largest customer were lost? If the answer is very little, then the company has virtually no customer concentration risk and, therefore, a higher value will be merited. If the answer is substantial, buyers won’t want to bear that risk without being handsomely compensated for doing so. Generally, if a company does not have a customer that accounts for 10% or more of revenue or profit, then there is little concentration risk.
- Management Quality and Depth: Buyers are concerned with whether the proven profit stream will continue after purchase. To the extent the business has a diverse group of top managers and employees that will continue with the business, the buyer’s perceived risk will decline. The result is a willingness to pay more for the business. Management depth, quality, tenure, experience, success record and education are all criteria of importance.
- Healthy, High-Growth Industry: Industry health and growth makes it easier to grow revenue and profits. Equally as important, competition tends to be not as fierce in expanding industries. There is enough business ‘to go around’ … so profit margins are higher. Find and serve an expanding industry and your job will be easier … as will your sale price. The stronger the industry, the higher the values.
- Multiple Industries: If the product or service offerings of a company are sold into multiple industries, a higher value is justified. The business can grow to twice the size (assuming each industry niche is of equal size) and enjoy meaningful industry diversification. For example, a maker of titanium tubing has traditionally sold to industrial customers, but has recently successfully penetrated the sports equipment marketplace. This business will command higher values.
- Proprietary Products: The more proprietary in nature of the products or services, the higher the value. In other words, is what you offer unique to anything offered by anyone else? Unique, of course, in a way that is meaningful or valuable to a certain customer group or groups? For example, a non-exclusive distributor enjoys little differentiation or protection from pricing pressure, whereas a manufacturer of a proprietary line of products should enjoy a more defensible market position and … higher profit margins.
- Product Mix and Diversification of Gross Profit: The greater the number of products and services the company sells, and the greater diversity of contribution to overall gross profit, the lower the risk inherent in business. Businesses with a healthy product mix and good gross profit diversification deserve and earn higher valuation multiples.
- Market Niche; Market Position; Brand Awareness; Identity: If a company fills a definable niche, commands a special leadership position in a niche or niches, or has strong and favorable brand awareness in its market, the business probably enjoys higher profit and growth rates. As such, buyers will pay more.
- Low Debt: While debt is not really a value driver, it substantially affects the net-cash received by the seller. When a business is sold, the seller basically sells the net equity of the business. Whether the sale is affected via a sale of the business’ assets or shares of stock, something must be done with the debt of the business. If the buyer assumes the debt, he or she will do so as a form payment to you, lowering the cash you get at closing. Further, in an asset sale you’ll owe federal and state taxes on the amount of debt assumed by the buyer. If the buyer does not assume the debt, the seller will have to pay off the borrowing WITH AFTER TAX DOLLARS.
- Interim Results: Buyers are interested in what the business will do in the future. The best indication is the present. Strong current performance can justify higher prices, and a dip in performance will quickly deflate value.
- Off Balance Sheet and Contingent Risks: Risk and uncertainty lower values. If elements such as the following exist, correct them … or wait for the issue to subside … before attempting to sell your business:
- existing or pending litigation.
- real or possible environmental liabilities.
- lease problems or uncertainties.
- industry or market uncertainty.
- customer concentration.
- Future Maintenance Costs and Capital Expenditure Requirements: For the business to earn the profits projected by the buyer, or to continue to expand, how much money must be spent? Can the existing assets and staff handle the production requirements for the foreseeable future, or will new dollars have to be spent to replace, expand or … worst case … relocate? Future capital expenditure needs will have to come out of future profits, lowering the value of the business.
- Quality of Financial Information: Financial statements present the financial condition and performance of a company. To the extent that a buyer feels certain that these reports are accurate and may be relied upon, his or her perceived risk will be low. So, keep detailed and accurate books and records that will breed comfort and confidence in them. The result is a willingness to pay more for the business.
- Appearance: Does the business “show well?” Is it attractive in appearance? Is the facility clean, painted and bright? Does the office appear clean and organized, or cluttered and unprofessional? Are the logo, marketing materials and website up to date and convey a positive, vibrant image? Just as a clean and waxed car sells for more, so will a business.
- A Growth Plan: Buyers are interested in the future. Lay out a path for significant future growth and profit and … if the buyer believes he or she can make it happen … he or she might be willing to pay more. At times, much more.
The above list is not meant to be all-inclusive, but is fairly comprehensive in scope and touches on the key areas of value and risk typically investigated and considered by buyers of businesses.