There are many factors that play a role in determining the worth of your company on the market. In this review, we take a close look at how to determine the worth of your company through the identification of value drivers during a business sale. Specifically, we focus on looking beyond the financial aspects of your business alone to ensure the full accurate value of your company is represented before you begin marketing your company to potential buyers.
What is My Business Worth?
Many business owners who are planning their exit strategy expect the valuation to be a simple and straightforward calculation. However, the valuation stage is much more complex and involves more than your financial information and rule-of-thumb data.
Although your company’s financial performance is important and one of the most important considerations for potential buyers, there are many additional elements. Below we discuss the core elements that are included in a business valuation. We also discuss the different valuation methods that brokers may use and how to consider the “uniqueness” of your company when finding your value.
The Core Elements of a Business Valuation
The first thing we should look at are the core elements of a business valuation. Most core elements are what you might expect, such as your financial information and your location. However, every business valuation should be individualized. In creating your individualized profile, you should consider the following core elements:
- Technology solutions
- Intellectual property
- Unique clientele
The Different Types of Valuation Models
A good business broker determines the value of your company with as many facts, financial figures, and other objective measures as possible. However, there is always an element of subjectivity involved. The ultimate goal is to determine your worth on the market, particularly if you are selling your company. The three primary types of valuation models are as follows:
- Market-based valuation
- Asset-based valuation
- Income-based valuation
There are three main valuation models. A market approach is the most common if you are selling your company. However, an asset-based valuation or an income-based valuation may be used to supplement the market approach. In other cases, such as if your company has numerous assets that are the main value driver for the business, an asset or income-based valuation may be used as the primary model.
Although a market, asset, and income approach are the three primary types, there are other valuation models that may be applied as well. For instance, some brokers use historical earnings valuations, future maintainable earnings valuations, relative valuations, and discounted cash flow (DCF) valuations.
Considering The Uniqueness of Your Company
At Sigma Mergers and Acquisitions, we are asked all the time by sellers if we have sold businesses such as there before. The answer is complex. Yes, we have sold more than 600 businesses, so we have likely sold one that is highly similar to yours. However, we have not sold your business specifically.
Your business is unique, unlike any companies that have sold before you, and different than all of your competitors. So, why is this important to understand? Because finding your company’s unique value should include a personalized assessment and go beyond a simple application of rule-of-thumb data.
Other business brokers who only consider a company’s financial information often miss the most valuable elements of a company, leading to selling prices below what the seller could have otherwise received had the broker conducted a more detailed and personalized value assessment.
The Ceiling of Hidden Value and The “Comfort Trap”
Briefly, we want to discuss the hidden value of your company. For most business sales, the seller’s primary goal is to maximize the sale price. Of course, there are usually non-financial goals for the sale as well, but every seller wants the highest sale price possible. In order to achieve this, it is important to find the hidden value of your company, which may not show up on financial reports. As discussed, this could be in the form of strong and proven internal systems, employees that are well-trained and have been with the company for years, and an optimistic industry outlook. When you can identify and highlight these elements (which are far too often hidden), then you can truly maximize your company’s value.
Unfortunately, many companies do not reach this maximum sale price as they are stuck in what is known as the “comfort trap.” This occurs when you focus on the easier-to-identify factors of your company, such as your revenue, profits, location, and industry competition. This leads to a lower sale price even if it is considered “fair market value.” With the right process and by selecting an experienced broker who sees your company’s value, you can break through the comfort trap and ultimately place yourself in a position for a much larger sale price.
What Are The Most Important Value Drivers for Your Company?
The most important value drivers are unique for every company. There are dozens of potential value drivers. Below we discuss some of the more important value drivers in the eyes of buyers. However, your list may look much different depending on the specifics of your company and situation.
Employees are an asset. In fact, they are one of your most valuable assets. However, they do not show up on the balance sheets. So, how do you measure the worth of your existing workforce? Although this is relatively subjective, a more experienced workforce allows for less involvement from ownership and makes the transfer of ownership much easier. On the other hand, a lack of experience and a high employee turnover rate is a problems that you must address when you market your company.
Quality Books and Financial Records
Potential buyers place value in organized financial records and bookkeeping. This lets them know they can trust the numbers you report. On the other hand, disorganized bookkeeping could make potential buyers have more doubt about your reported numbers. Also, a lack of necessary financial documents can also make selling your company for a fair value far more challenging.
Location. Location. Location. This not only applies to real estate, but it also applies to your business. In many cases, the company’s location is the determining factor between a business thriving and opening multiple locations and going out of business. Of course, retail stores (and other forms of in-store businesses) are most impacted by location. In fact, the location of many retail stores is often the main value driver, especially if the seller owns the land.
Length of Time in Business
Your most recent sales performance is incredibly important in determining your value. However, potential buyers are also interested in the length of time you have been in business.
Potential buyers are also interested in understanding how involved you are in the sales process. Ideally, you should have systems in place that allow you to be less involved. This does not necessarily mean heavy involvement works against you. If you have employees in place that understand how to carry out many tasks involved in your daily operations, then the buyer can project how involved they will have to be. However, if you are the only one who can do what you do daily and are heavily involved (40+ hours per week), then this could negatively impact the value.
Your market methods also impact the value of your company. For instance, if your company is operating successfully without essentially any investment into marketing and advertising, then a potential buyer may see this as a great sign that your company has growth potential.
However, if you have a significant marketing budget but are not seeing a sizable return on investment (ROI), then this may be something that needs to be addressed when you sell. Keep in mind, a poor ROI on marketing is usually more representative of a need for a new marketing strategy, and it is not necessarily a major knock on your company’s valuation if it is addressed properly during the marketing and negotiation stages.
Potential buyers will also view your customer concentration as either positive or negative. For instance, if only 10% of your revenue and profit comes from one client, then this could be a sign that you have a diverse enough clientele to overcome the loss of your main client.
On the other hand, if 50%+ of your profit comes from one client, then this could be something you need to explain in greater detail so as not to alarm prospective buyers of your company’s long-term prospects. Specifically, you would need to highlight why the main client is not a threat to drop your services and/or highlight ways other large clients can be acquired with new ownership. Otherwise, a high customer concentration with one client could negatively impact the value of your company.
Value Drivers: An Example of How to Identify The Unique Value for Your Company
Every company is unique. Although the aforementioned value drivers are common, your value drivers may look different. Here is an example of the types of unique value drivers your company may have.
- Quality workforce (employees)
- Quality of books and records
- Good location (high-demand area with low competition)
- Been in business for 50+ years
- Owner involvement is less than 15 hours per week
- The largest customer is only 10% of the revenue
- There is a high barrier to entry
- The industry competition (and the threat of competition) is low
- The industry is growing
- Your company has proprietary software
The Importance of Identifying Areas Where Improvements Are Possible (With Example)
Potential buyers are not just interested in what your company already does well. After all, they likely are already familiar with your earnings and the industry size and trends. Oftentimes, potential buyers are more interested in the answer to how the company can grow. As the owner (and perhaps the founder), you have better insights into this question than anyone.
All too often sellers shy away from discussing growth opportunities as it means admitting that the company may have areas where they are not already performing at the highest level possible. Instead, however, it is important to remain transparent about growth areas even if it means highlighting company “weaknesses.” In many cases, this also allows potential buyers to trust you more and have more willingness to make a fair offer.
So, what are the types of improvement areas you might list? This is, of course, unique to your company. However, as an example, a company may list the following as “areas for improvement:”
- New sales representatives could expand the sales numbers
- A focus on new technology could lead to more long-term clients
- The location is great, but the current office has a high lease cost
- The need for owner involvement could be diminished through more delegation and employee empowerment
Receive Your Free, No-Obligation Valuation From Sigma Mergers and Acquisitions
Sigma Mergers and Acquisitions offers free, no-obligation business valuations. Our accurate and objective valuations give you a better sense of when (and for how much) you sell your company. If you would like to get started with a valuation or simply want more answers to questions you have about your exit strategy, contact us today.