How a Business Valuation Can Enhance the Value of Your Company
A Valuation Provides a Roadmap for Improvement
There are many reasons a business owner may want to obtain a business valuation, and the first among them is that the owner will want to exit the business at some point. An independent valuation performed by a business valuation professional will be necessary to support the asking price if the company is to be sold to an outside buyer.
But business valuations are also necessary for other types of exit plans, including selling or gifting the business to a family member or selling to employees. Additionally, a business valuation can be an important component of an estate plan.
A best practice is to obtain a valuation as early as five to seven years before a planned business exit, giving the owner time to make improvements to the business, enhancing the value of the company when another valuation is calculated when the owner is ready to go to market.
The Levers of a Business Valuation
The key levers of a business valuation are:
A higher cash flow means a higher value for the business. A business valuation professional will typically look at the most recent five years of your company’s history to ascertain trends in cash flow. A stable trendline will impact the value favorably, and that’s what potential buyers want to see.
Certain events can impact your cash flow, such as bringing a new product or service online. When your business is expanding its offerings, some strategies to protect your cash flow include setting a realistic budget and sticking to it and putting together sales and revenue forecasts. A valuation professional will look at those forecasts to see if you hit your marks.
Higher growth also means a higher value for the business. A valuation professional will look at your company’s organic growth and, in particular, your pricing strategy, especially now that we are in an inflation cycle. If a company is paying its employees higher salaries and paying more for raw materials and components, its pricing strategy must keep up in order to protect cash flow.
Does the company have a recurring revenue stream, with many returning customers influencing a stable growth pattern? This is a positive factor that potential buyers would like to see. However, it’s a double-edged sword because an over-concentration of sales to the same customer base can also be viewed as a risk factor if those customers could suddenly disappear.
Companies that build routine maintenance contracts on top of their core business – such as heating, ventilation and air conditioning contractors – are also attractive to buyers because they have diversified their revenue streams. The same applies to technology companies that sell their products and services on a subscription basis.
Lower risk is the third factor that drives a higher value. Significant levels of risk in a company translate into a discount rate on the valuation.
Many factors influence the level of risk a company is perceived to have. An over-reliance on a concentrated set of customers in a single industry is a risk factor, as is a company’s over-reliance on a single key manager.
Other risk factors can include sourcing issues. If your raw materials and components come from China, do you have backup sources in the U.S. or other parts of the world? We have all seen recently what a supply chain disruption can do to companies and whole industries.
Diversification of customer groups and supply sources, as well as product and service lines, help spread and dilute a company’s risk factor in a business valuation.
Leverage is another risk factor, one that is growing in the current inflationary cycle. Highly leveraged companies – particularly in a high interest rate environment – can see their cash flow negatively affected, especially if they have variable rate loans.
How Business Valuation Enhances the Value of a Company
A business valuation reveals vulnerabilities that every company has. A good valuation provides a roadmap for improvement, serving as a starting benchmark against which you can measure the company’s value again three to five years down the line after making improvements.
Many of those improvements may be made in the area of financial management and operations. But some may be made in key non-financial, non-operational areas that also influence valuation.
Some of the non-financial factors that impact a valuation include:
A written internal succession plan identifying key employees is an important document that can enhance the valuation of a company and give potential buyers peace of mind about the transition to ownership.
A written, up-to-date buy/sell agreement is like a will for your company that spells out what would happen if you or a partner were to die or become incapacitated.
Life insurance policies on key persons in the company – specifically owners and possibly key C-level executives – also enhance value by showing potential buyers that the owners have kept the company’s best interests in mind by ensuring its smooth transition should an unforeseen death occur.
Technology, intellectual capital, work processes and manufacturing processes are all examined during a business valuation. Keeping the company’s key processes up to date and aligned with your competitors and your industry can help build and maintain value.
What is the state of your physical facility? Is it well maintained and as attractive as possible? Are the furnishings and equipment in good working order and free of blemishes? Is the physical location advantageous for customers who must visit you?
If the answer to any of these questions is “no,” take the time and make the investment to improve the facilities before you get a final valuation in preparation for taking your business to market.
A business valuation can serve many purposes, and for owners who are putting in place exit or succession plans, a benchmark valuation can help frame the exit preparation for the next five to seven years. If you would like to discuss obtaining a business valuation for your company, contact an Adams Brown advisor.