With the acquisitions market heating up, the right valuation for a business should be at the top of an entrepreneur’s to-do list, says an industry expert.
Monitoring value is essential in any economic environment, but especially when the market is moving fast. Although the pandemic slowed Florida’s business sales in 2020, the number of business owners looking to sell began to climb at the start of this year and has continued to grow, according to Green & Co. Business Brokers. Even if an owner isn’t ready to sell, most want to maximize the value of their business. Ideally, business owners and their management teams should begin monitoring value at least five years before considering an exit.
Most people assume valuation is a quantitative science focused solely on financial statements, forecasts, multiples and rates of return. But it’s often more qualitative.
Valuation is a determination of future business expectations. To accurately determine those expectations, it’s critically important for a business owner to identify and understand what drives value. What factors increase cash flows and reduce risk? We believe these seven factors, which apply to most businesses, are essential to increasing cash flows and reducing risk — thereby enhancing overall company value.
1.Capital access. The smaller the company, the more limited its access to debt and equity capital. The company will need to assess the kind of capital needed to achieve its goals.
Questions to ask: How is the company currently leveraged? How do lender covenant restrictions impact the business and its future plans?
2. A diversified customer base. When companies flourish by catering only to their largest customers, dependency may increase to the point where too great a percentage of revenues are concentrated with too few customers.
Questions to ask: What percentage do the top five customers contribute to the company’s revenues? What amount of revenue is recurring? What’s the economic useful life of its entire customer base, as well as its largest customers?
3. Financial performance. Conducting a financial analysis aids in measuring trends, identifying the assets and liabilities of a company and comparing the financial performance and condition of the company to its peers.
Questions to ask: How does the company compare in terms of liquidity, activity, profitability and solvency measures? Are financial controls in place? Are the financials audited or reviewed by an outside CPA?
4. Human capital. This can’t be discounted. A company’s employees are the heart of an organization. Key value drivers include the knowledge, skills, experience, training and creative abilities employees bring to a business and the health of its company culture.
Questions to ask: How is the company managed? What’s the depth and breadth of management? Are there key person dependencies in terms of technical knowledge, production skill, or customer contacts? Is there a succession plan?
5. A company’s value is intertwined with the market environment. Each business is affected by economic trends and developments in the industry in which it operates. Management must understand how economic factors play a role in the industry and how the industry is structured to minimize the impact of macro trends on the business.
Questions to ask: What’s the company’s market share? Where’s it positioned in the market? Does management understand its niche and unique offering? Is it diversified to modulate the impact of economic swings?
6. Most companies put together a one-year budget, but fewer assemble a fully developed business plan or a long-term forecast. Valuation is all about future expectations, and company management needs a strategic vision to create value. Management must examine all the material gathered from reviewing their company to formulate a strategic vision that can be shared with the subsequent owner, providing additional support and assurance of continuity.
Questions to ask: What’s management’s long-term outlook? When did the company last write a formal business plan? Is the company’s strategy in tune with its customers’ demographics, tenure, needs and demands?
7. Technology. Companies with fewer financial resources often lack adequate research and development investment, making it challenging to keep pace with evolving technology in their markets. Such companies often face an inescapable and imminent need to incur large amounts of capital expenditures or allocate resources to a limited number of product development projects. This inevitably results in product or service obsolescence, adverse impact on future growth, and loss of market share.
Questions to ask: What resources does the company allocate to R&D? Is the use of technology up-to-date?
Ongoing assessment of a company’s value drivers is integral to success. The valuation process involves both a quantitative and a qualitative evaluation of a company that should be part of any business owner’s standard operating procedure as a useful and essential business management exercise. A valuation assessment can provide the business owner with meaningful and often actionable information that highlights the real intrinsic value of the firm and ultimately helps maximize performance.
Chris Krapfl is a senior vice president with Valuation Research Corp, a full-service, independent, global valuation firm. Based in Tampa, he specializes in valuations of capital stock, business enterprises, and intangible-assets for financial reporting and tax purposes.