Valuation Methods are Built Around Key Growth Drivers

Business valuations are often sought by owners who are not sure what their long-range plans are, but who know they want to grow their businesses, and obtaining a valuation can help them frame their thinking.

A key question early in the process is “Do I achieve growth by buying another business and bolting it onto my existing company? Or do I grow organically by expanding my product lines and seeking new markets?”

The buy-or-build question is a heavy one with ramifications for the company’s growth cycle. Both strategies can help achieve growth, but buying another company carries significant risk, and growing organically takes time.

Either way, a business valuation can help determine the best course by yielding such information as current pricing multiples in an industry or geographic region, as well as current asking prices. Moreover, it can help determine the need for financing or outside investment to fuel the growth cycle.

While business owners do not typically seek a valuation as they begin a growth cycle, some find it useful if they are preparing for eventual sale or succession. Doing the valuation at the beginning of a growth cycle can help determine the growth strategies and tactics that will get the company to the point of exit. However, the owner generally would not realize the value until the company achieved a stabilization point.

Valuation Strengthens your Case with Investors & Lenders

Growth nearly always requires capital. Whether you’re seeking private equity investment, bank financing, or strategic partnerships, stakeholders want evidence that your business is a sound investment. A valuation provides that credibility.

Investors and lenders look for:

  • Transparent financials
  • Realistic growth projections
  • Clear understanding of market risks
  • Demonstrated value creation potential

A valuation packages these elements into a structured, objective report. It signals that you understand your business deeply and are committed to disciplined growth. This can lead to better financing terms, higher investor confidence and faster deal cycles.

Valuation Methods for a Growing Company

Businesses go through growth cycles and stabilization cycles. During the growth cycles, they build their teams or their manufacturing lines and work toward a growth goal. When they get to where they’re going, they stabilize.

A valuation professional will tailor methods and approaches differently for a company entering a growth cycle than for one that is stabilized.

For instance, considering a stabilized cash flow benefit stream in the income approach would be used for the company that is not on the cusp of a growth cycle. However, determining projections and discounting them to a present value is commonly used for companies where investments have been made to allow for high growth. Utilizing projections, an appraisal analyst should consider that the return of capital is speculative, so the discount rate should consider the higher risk.

Capital expenditures going out five years would be built into the valuation, as would any anticipated increase in margins resulting from new efficiencies achieved by the expenditures on new equipment or processes.

From these assumptions, the amount of revenue growth that the company could achieve is built into the valuation. The valuation range would be based on the difference between what is projected if the company were to remain the same, as opposed to what it could achieve by expanding. A notation would be made as to how many years it may take for the company to reach the higher value.

Generally, to reach a realistic value range for a company entering a growth cycle, the valuation model must be built with the assumption of an increasing debt load, increasing working capital needs and increasing capital expenditures. For owners who are debt-averse, this can be a nerve-wracking experience.

Valuation Considerations for Growth-Oriented Owners

The reasons for seeking a valuation before embarking on a growth cycle vary with each company:

  • Some owners seek a valuation when they want to sell at some point in the future, so they can learn what type of runway they have and whether they will reach the stabilization point by the time they want to exit.
  • Buyers often look for companies that are in a growth cycle, so they may seek a valuation on a target company to determine whether it has the exponential year-over-year growth they seek, as well as clarity on how the growth has been achieved.
  • Other buyers are building their own businesses and looking for a “bolt-on” acquisition that will help accelerate their growth.
  • Some owners are planning for an exit that brings as high a price as possible, potentially selling to a private equity buyer. The question of whether to achieve that goal by building their growth or buying it can be settled, in part, with a valuation.

What Information Does the Owner Contribute to the Valuation Process?

For a realistic, accurate valuation, an owner whose company is in a growth cycle should provide the valuation professional with key pieces of information:

  • Growth projections
  • Current and projected profitability margins during the growth cycle
  • Balance sheet items such as how fixed assets will increase during the growth period, whether the owner will finance or use reinvested capital to fund growth, and whether the company will add more leverage or use earnings they are accumulating.
  • If the company is a manufacturer, an understanding of inventory changes during the growth cycle must be reached.
  • If the company is a service-based business, the valuator will want to know how their workforce costs will change during the growth period.

When a Buyer Requests a Valuation

Owners who are looking to buy businesses in order to bolt onto their existing company to achieve growth goals often request valuations of target companies. A valuation helps them determine whether the target is a good business for them to acquire, can provide modeling that projects what their integration costs would be and what their potential is for increased margins due to economies of scale.

This is a savvy move for business owners who intend to keep their companies running for many years and want to minimize the chance that private equity investors or another growth-minded business owner might snap up competitors in their region.

Questions?

Companies embarking on a growth cycle may benefit from a business valuation to help guide them and prepare their companies, plan for capital needs and target growth strategies that will help them realize their goals as quickly as possible.

If you would like to discuss your company’s growth plans and how a business valuation may help you achieve your goals, contact an Adams Brown advisor.