How to get the best business valuation?
It’s a topic of great interest for both buyers and sellers.
According to Google’s Keyword Planner, on average 10,000 monthly searches are conducted on the term business valuation alone.
Clearly, there are scores of people eager to understand valuation and its importance during mergers and acquisitions.
It’s a no-brainer.
Being prepared allows you to maximize your returns as well as minimize your risks.
And by giving careful consideration to value drivers, sellers will be able to position the company favorably to show good cash flow and reduce apparent risk; while buyers know which metrics to keep an eye on.
So, before we take a look at the key value drivers to focus on, you may be asking but what are value drivers anyway?
Let’s find out.
Value Drivers Defined
The Corporate Finance Institute gives us a clear definition of business valuation drivers or value drivers. These are:
“…factors that increase the value of a business in the event of a sale opportunity.”
It follows then that every business has value drivers but not all value drivers are equal.
There will be some businesses that bear industry-specific value drivers. In summary, there are generic and specific value drivers.
Armed with a clear understanding of value drivers, let us turn our attention to the drivers you should be cognizant of during business valuation.
Value Driver #1 Financial Metrics
A business’s financials are arguably an essential part of the valuation.
The better the quality of the financials, the cleaner those financials, the higher the value of that business because it becomes easier to get that business financed if you need to go get a loan.
Example questions to ask pertaining to these metrics include:
- What is the quality of the financials like?
- How clean are the financials?
- Are these financials a true reflection of operations?
- Does the business have debt?
- Does the balance sheet add up?
- Is inventory flow represented honestly?
Unclear, inconsistent, and incongruous financials drive down the value of a business.
Value Driver #2 Recurring Revenues
When companies have recurring revenue, it drives the value of a business up because there’s some consistency there. You can rely on those revenues coming in on a monthly basis.
Without consistent business, a company will soon run aground. Does the company you’re interested in have loyal customers? Regular clients? Or retainers?
These questions and the volume of monthly revenue must be known in order to ascertain just how much work you’ll need to put in to keep the business running.
The more work you will have to do to secure new clients, the lower the value of the business.
Value Driver #3 Owner Involvement Level
The risk goes way up when you take over a business that the owner was so involved in. Those types of companies tend to get a lower value.
Businesses that revolve around the owner are exceedingly difficult to take over.
It’s not uncommon to find that most small businesses were founded on the personality and strengths of the owner.
This can make operating difficult as, without the owner, the culture and essence may shift the business’ dynamics considerably.
If on the other hand, there is minimal owner involvement it makes the transition smoother and improves business valuation.
Value Driver #4 Employee Caliber
Questions to ask in order to understand the role of employees in the company include:
- What’s the culture like?
- The turnover rate?
- Are there any employees who if they left, their absence would cripple operations?
- Have the employees signed non-solicitation clauses?
- How autonomous are the employees?
Having an exceptional employee base is great and can certainly reflect favorably on the value of the business, but employees should not become liabilities.
Value Driver #5 Barriers to Entry
How easy is it for others to set up shop in the industry the business you wish to purchase operates in?
Is there any technical know-how that makes it an exclusive niche?
Who are the main competitors and the industry’s dominant players?
Knowing this particular piece of information is key in evaluating the competitor’s risk.
When the barrier to entry is high, the business merits a little bit more consideration when it comes to value.
The more specific the niche, the higher the barrier to entry, the better the valuation.
Value Driver #6 Business Systems
Does the business have clearly defined business systems and processes in place?
Well-defined company practices make the transition easier and demonstrate the level of care, thought, precision, and foresight the owner has.
It should give you confidence. And consequently, the clearer the systems the higher the value of the business.
Owner and managing partner of Sun Acquisitions Domenic Rinaldi put it this way, “I always love when I see documented practices in a business. Infrastructure matters and will determine whether or not you’re decreasing or increasing value.”
Where Do We Go From Here?
These are six key value drivers you should be considering when analyzing offers and during business valuation.
If it appears intense, that’s because it is. There is a lot involved in mergers and acquisitions.
Fortunately, you don’t have to navigate the buyer/seller process alone.
At Sun Acquisitions, we’re an experienced M&A firm that can assist you in evaluating offers and further understanding value drivers. Don’t hesitate to contact us.
