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Understanding your business valuation is one of the first steps of positioning your company to sell. Many business valuation methods focus on the company’s financials, specifically sales and profitability. Unfortunately, many business owners focus on these business valuation methods and miss out on other opportunities for increasing the business’s valuation.
When a buyer determines the worth of a company they will focus on a number of things. These value drivers help a buyer determine the risk associated with purchasing a business and can help influence how they view business valuation. Focusing on addressing these business valuation methods can allow you to enhance your valuation without increasing sales.
One of the most important business valuation methods for a buyer is cash flow. Seeing a positive, regular cash flow is extremely favorable to a buyer. In fact, buyers see cash flow as a direct measurement of a business’s risk and the risk during the transaction. Buyers that are able to see positive and increasing cash flows are willing to pay a higher price for those things and will place a higher valuation on the company.
Accuracy of Financial Information
Having solid, accurate and audited financial statements provide assurance that the business’s position is as it is being presented. While the buyer will undoubtedly do their own research, having thorough records supports a business owner’s assertions about profitability. Presenting documentation that is inaccurate or incomplete can cost a seller the deal. If the deal does go forward, the valuation provided by the buyer will be significantly lower.
Buyers can look at a business’s customer base as another business valuation method. Companies that have a limited number of customers will be seen as riskier. Especially if losing one customer can significantly hurt the company’s bottom line. A mix where no customer is responsible for more than 10% of revenue is ideal. This is especially critical to buyers as there is an inherent risk that customers will leave due to the change in ownership.
Buyers of business are looking for well-run companies with a high quality workforce. With few exceptions, buyers are looking for situations where the existing employees and management team plan to remain with the company and continue to manage day-to-day operations. Moving forward with quality employees helps buyers to know that they will retain the expertise and human capital that has allowed the company to be successful thus far. If a company’s employees are not able to run the company without the owner, this is seen as a risk by the buyer and will result in a lower valuation. The existing workforce quality is often overlooked by sellers, but is one of the most important business valuation methods.
Potential for Growth
Potential for growth is one of the easiest ways to demonstrate why a company is worthy of a higher valuation. It is important to show how and why a business will continue to grow after the sale along with supporting documentation. Developing a growth plan can help to showcase why your business should be seen is having growth potential and can highlight areas of growth that the buyer may not have considered. While developing a growth plan, business owners should think about:
- Marketplace – Is the company in an industry that is growing or that is poised for growth?
- New markets – Does the company have potential to move into new markets based upon its existing offerings?
- Customer penetration – Is the company currently maximizing its relationships with its existing customers? Are there new ways to continue to develop existing relationships to get additional revenue?
- Technology – Is the business in a sector where it can leverage existing technologies?
- Marketing – Are there marketing possibilities that are not currently being utilized that can result in higher revenues in the future?
- Competition – Are there opportunities for growth based on the competition, acquiring other companies or filling voids where competitors are not active?
Policies and Procedures
It is not enough for a company to use policies to manage a business. If those policies and procedures are not clearly documented, the company runs the risk of losing productivity if existing employees leave. Documenting processes, establishing manuals and creating a centralized document control system can help buyers to feel comfortable that a transfer of ownership will not result in a loss of knowledge.
Additionally, having firm, documented policies and procedures in place allows buyers to see how well managed and effective your business truly is. Think about documenting the following:
- Best practices for hiring, training, retaining and reviewing personnel.
- Detailed information on employee benefits and an employee manual.
- Customer information housed in a centralized location.
- Procedures for establishing a new customer.
- Quality control, inventory and operating procedures.
- Customer service policies.
- Formats for communicating internally as well as with vendors and customers.
- Scorecards or reporting methods documenting employee performance.
- Scorecards or reporting methods for evaluating vendors.
- Standardized reporting on business results.
Reputation is one an extremely important drive of value and it can be difficult to quantify. Having a strong name in the industry or a reputation for having good business relationships can be appealing. This is true even if a business does not have a lot of assets or is relatively new. Reputation can be hard to come by. Customer loyalty and brand awareness provide an added layer of value that many buyers are willing to pay a premium for.
Competition is one of the foremost concerns of any business and to the perspective buyers of a business. Businesses that have competitive advantages are seen as less risky and can garner a higher price than those without those advantages. Competitive advantages that simultaneously help the business and limits the competition are especially valuable. These things include:
- Industry secrets
- Media overage
- Brand names with recognition
- Trade secrets
- Exclusive contracts
- Unique software
- Extensive training system
- Reputation as a leader
Being able to speak to these competitive advantages can further demonstration why your company is deserving of a higher valuation.