Business valuation is driven by your company’s future cash flow prospects. Without the promise of reliable future profits, your company’s value may suffer. As a business owner, it is important to understand the drivers of business valuation when trying to maximize the value of your company.
Since a key aspect of value is the ability to replicate sustainable cash flows into the future, for as long as possible, the fundamental question every owner should ask themselves is, “What drives the value proposition for my business?” Most of the time, the answer will involve the ability to offer a profitable product or service. But let’s dig a bit deeper into five critical elements of business value.
1. Growth drivers
The ability to display growth potential is a primary driver of value and is something that potential investors, buyers or partners are always looking for. However, successfully driving growth requires never being comfortable with your business, as complacency generally leads to declining value or vulnerability from competition.
The companies that continue to succeed and build value are the ones that are constantly investing in process improvement, innovation and product development with aspirations of finding that next big thing. By doing so, they are hitting on many of the drivers that positively impact valuation, such as creating a recurring revenue model, diversifying their products or services, creating their own intellectual property and maintaining state-of-the-art facilities.
2. Intangible drivers
Intangible value is the value beyond the physical assets of the business. For mostbusinesses, the value in brand recognition is immeasurable. Brand recognition is whatkeeps customers coming back to your product or service; without it, your company loses itsability to generate recurring revenues, which are critical in measuring value.
Your management team should regularly review how your customers perceive value and whether your business is meeting those expectations. This analysis should go beyond just quality and evaluate the entire customer experience. Your business can have the best product or service in the market, but if the experience your customers have when dealing with your company is less than stellar, your product quality won’t matter and your customers will look for alternatives.
3. Efficiency drivers
Value creation can also be achieved with improved processes. By implementing more streamlined and efficient processes through the course of producing your product or providing your service, your company will be able to offer a lower price than your competitors while still maintaining similar or better profitability. You’ll also be able to increase market share, which will improve brand recognition.
4. Structural drivers
Employees are the most valuable asset of a company, and one that does not show up on a balance sheet. Business owners should pay particular attention to their management team, which serves as the backbone of the organization. If your business neglects to develop and retain those individuals who are so critical to the organization, they may be recruited away by a competitor who is looking to get a leg up.
The knowledge and skill sets of your workforce are difficult to replace without significant time, cost and effort. Having to constantly retrain or develop new members of management is a distraction from other activities that should be your company’s focus.
In addition to employees, implementing solid infrastructure, processes and systems adds value to your business. A well-developed infrastructure will serve as a stable platform to support your company through continuous growth while mitigating the effects of unforeseen hiccups and growing pains.
5. Financial drivers
The four drivers discussed above require time and investment before a business owner can bear their fruits. However, once all of these drivers are in place, your business should see its financial performance increase. You can then focus on fine-tuning financial metrics, such as net income, SDE (seller discretionary earnings), and EBITDA (earnings before interest, taxes, depreciation and amortization).
Focusing on tasks and objectives that increase your company’s value will not only drive short-term results, but more importantly, will also allow owners to maximize the valuation upon a future sale of their equity interest in the business. Even though a sale may not be in the immediate future plans, it is still wise to focus on valuation factors in the event that an unexpected, unsolicited offer is made.
Whether you are looking to sell your business, transition ownership, conduct estate planning, or calculate gift equity, the first step is to determine the value of your business. Learn more about business valuations here.
Brian J. Sharkey, Director-in-Charge, Business Advisory, Kreischer Miller