A common misunderstanding about business valuation is that the calculation is based solely on financial performance, but the numbers often do not tell the full story. While financial performance is essential, other value drivers are not captured in the financial statements. Some value drivers such as brand recognition and strong customer relationships are qualitative in nature, but they support a business's ability to generate future cash flow. These value drivers, in aggregate, provide investors the framework for assessing the risks associated with future performance.
PCE's Operations Assessment examines your business's 18 value drivers to identify where value is generated and where there are opportunities to increase business value. We take a holistic approach by looking at your business through the lens of the following key value drivers.
If your business model is overly complicated, it will likely attract less attention from investors. An easily understandable business model is invaluable. As a business owner, you should be able to quickly provide an outside investor a holistic understanding of your company's performance, practices, culture, discipline, and mission. A well-documented strategic plan supporting the vision, mission, goals, and objectives is crucial when you are contemplating a sale. Investors want to know that your company has a strong growth strategy.
Financial statements provide the most insight into your business's ability to generate cash flow and will be relied on the most heavily for investor decision making. For this reason, high-quality financial statements are critical to your company's sale and should be audited or reviewed to assure investors. For additional clarity, you should consider obtaining a quality of earnings analysis from a third-party accounting firm. Maintaining records of non-business-related expenses will also come in handy when preparing addback adjustments to pro forma financial statements.
Margins show your company's efficiency at making money and are a crucial financial indicator for investors. You should have a documented process for margin improvement efforts to better inform future projections and create business value. This documentation is vital for an investor to understand your company’s future cash flows.
BARRIERS TO ENTRY
The barriers to entry in your industry can directly affect your business's value. The obstacles facing a new market entrant can be legal, market-specific, or capital-related in nature. Start-up costs and time to build a new business are typical obstacles for new market entrants. These barriers reduce the threat of new competitors entering the marketplace and taking market share from a business.
DOMINANT MARKET SHARE
If your company has a dominant market share, it will be viewed more favorably by investors. Dominant market share often indicates the company generated the highest profits within a given market by maximizing cost efficiencies. Business owners who monitor their market share and keep documentation are better prepared to support their dominant market share claims to investors. These businesses are typically more knowledgeable about their competitors and better equipped to compete.
LARGE POTENTIAL MARKET
A valuable company is one with significant opportunities for growth. Larger markets are ripe for expansions and consolidations from an investor perspective. Market leadership in a niche segment is also an indicator of attractive business potential. Companies that maintain documentation of the market potential are usually forward-thinking in their growth and market share capture strategies. Growth potential is a significant investment criterion for most investors.
Investors are investing in your senior management team's ability to perform. Most investors are not interested in running the day-to-day operations and therefore are very interested in your senior management. A senior management team consisting of industry experts and leaders is key to success. Additionally, company culture is often set at the top as senior leadership drives the vision and mission.
A strong human resources team will be able to depict each employee's role within your organization and their contribution to the overall success of your business. Company value depends on recruiting individuals who contribute most effectively to your company's quality internally and externally. Recruiting the right people can strengthen your business's culture, customer relations, production, and innovation.
Potential buyers and investors pay close attention to customer concentration. Any company benefits heavily from a well-diversified customer base due to the decreased impact a lost customer would have on overall revenue. Valuable companies will have a nice mix of new customers, developing customers, and long-term customers. A customer representing more than 10% of your company’s annual revenue may concern some investors.
Your company's ability to generate recurring revenue can be a strong indicator of future performance. Multiyear contracts or a history of repeat customer business support revenue projections. Your company's ability to derive stable revenues also relies on overall customer diversification and retention. A robust contract backlog and sales pipeline will be vital to supporting revenue projections.
Legal & Compliance
Potential investors want to see that your company maintains substantial documentation and representation in all legal matters. It is critical to demonstrate to investors that your company is compliant with legal requirements and filings. Litigation details, potential liabilities, company contracts, and capital investments are aspects of your business for which investors will expect detailed supporting legal documentation. It is also important to disclose potential claims or threatened lawsuits.
SALES AND MARKETING
Sales and marketing are crucial to your company's ability to produce revenue in a proven and systematic way. This business aspect provides investors a framework for how you generate new leads and prospective customers. Sales metrics and analysis that demonstrate how past marketing efforts translate to actual revenue will better support your company's tactics.
Differentiated products and offerings are attractive to potential investors because they can often be priced at a premium to those of low-cost competitors. The strategy focuses on the uniqueness of your product offerings compared to your competitors', creating value for customers. Investors view product differentiation as a value generator because of the reduced threat of substitutes.
Strong brand recognition among consumers is highly valued. Building a brand that effectively communicates your company's mission and resonates with your customer base is an intangible asset that is difficult to create. A business with a strong brand should maintain records that support its strength. A market analysis demonstrating your brand's value is a powerful tool for supporting your company’s value to investors.
Client satisfaction surveys are a great management tool and a valuable marketing tool when selling your business. Investors are looking for supporting evidence of future performance, and high customer satisfaction is a strong indicator. A company that performs these kinds of surveys is more informed about customer preferences and can better react to changing tastes and demands.
Your company's ability to serve your customers efficiently is a crucial value driver examined by investors. Systematic and process-driven operations are better understood by an outsider valuing a business. Documentation of your operations and processes is valuable to investors because it serves as a "playbook" for your business. This documentation is valuable as it reduces key man risk and lost knowledge from key employees who may leave your business someday.
Your company's ability to demonstrate growth over time and identify future growth opportunities is critical in preparing for any transaction. Revenue growth is a primary variable for investors in evaluating performance. This value driver is notable when revenue has increased consistently year over year, is more significant than your competitors', and is greater than the forecasted industry growth.
Focusing on innovation is invaluable in creating an ongoing competitive advantage and bolstering business value. Investors look for proven and systematic processes that capture internal innovation and collaboration. You should quantify how your company rewards innovation culture and detail ideas that result in patents, copyrights, revenue growth, workflow efficiencies, and other financial improvements.
You will maximize your business's value by understanding its key value drivers and supporting documentation. PCE understands that valuation is a crucial consideration for business owners looking to sell their business. PCE's Operations Assessment is an excellent first step in making an educated decision on how to improve the value of your business. Please reach out to us as our investment banking and valuation experts are happy to answer any questions you may have.
This is the first article in our Value Driver series. Click below to explore the other topics.