July 29, 2020
Let’s start by admitting that what you “think” your business is worth, based on how you “feel,” isn’t a scientific, defendable position and therefore may not coincide with what a buyer will determine it’s worth to them through due diligence. Every successful business owner has committed untold hours, taken personal risk, sometimes gone without, and thus become emotionally tied to the fabric of the baby they have nursed from infancy to maturity. Let’s further agree that while a company’s future value is influenced by its past performance, that past performance in itself is not a good indicator of future value. (This is why many valuation models may be better suited for IRS defense, wealth planning, or perhaps divorce, but not necessarily sale preparation.) And while we are on this tantrum, let us also agree on the fact that “potential” that lacks a clear, tested, and proven demonstration of profitable effectiveness and scalability is really nothing more than a “wish.” Buyers do not buy wishes. They buy predictable, proven processes that lead to desired results. So if your company’s future potential is not defendable with plausible performance metrics, then that aspect of your formula will not count toward tangible, measurable, and transferable value.
At GaP, we classify transferable value (assets and goodwill) into 8 broad categories. These 8 headline categories have numerous subcategories, and this blog could get in the weeds really fast. Therefore, we will briefly touch on the 8 broad drivers of value and ask you to reach out to us if you want to dive deeper.
Value Driver Number 1: Financial Performance
There is just no substitute for consistently rising revenue and profit when valuing a company. No other metric even comes close, and showing a buyer a healthy history of increasing top- and bottom-line results takes a mountain of risk off the table for your acquirer. Strong financial performance effectively proves all the other drivers are working in a coordinated way and assures a buyer that efficient use of resources and wise decision making are in place.
Value Driver Number 2: Growth Potential
Didn’t we just dog “potential” in the opening paragraph? And now we have it listed as the 2nd driver of value. How does that make sense? Well, when you break acquisition strategies down to their most elemental root, buyers of businesses are interested in acquiring “a future stream of profits.” That is it! Now for you, selling your company is closing an era in your life, but for the buyer, this transaction represents the beginning of a new and exciting chapter. They need to see (or be shown) how they can scale the business to increase cash flow. They need to believe the business is just entering a growth phase (or that it’s capable of doing so under their stewardship) and that under their care, the business will reach new heights you may never have dreamed of. Growth potential - in the hands of the next, capable, energetic, and focused owner -is a big driver of transferable value.
Value Driver Number 3: Control your Destiny
Be independent! Overdependence on something (a large customer, a salesperson, a production engineer, a software system, a line of credit, a vendor, a piece of equipment, etc.) introduces risk in the eyes of a buyer. What if that person leaves or that key piece of equipment fails or your bank is merged with one having different philosophies? Having back-up vendors, personnel, systems, etc. - and occasionally testing and using those back-ups to ensure reliability - is a calming influence to a stranger who is trying to decide whether or not they offer cash or contingent consideration in a sale. It pays to ask the same “what ifs” a buyer will ask and then install systems to alleviate unnecessary concerns before you enter negotiations.
Value Driver Number 4: Be Self-Funding
Think about the speed at which your cash turns. Naturally, businesses that turn their cash faster are more valuable in this arena. Many business owners have been providing their service and then invoicing upon completion for decades – it is just the way things are done. But what if you could take 50% down, or get a deposit, or charge for materials up front? Those payment mechanisms would make your cash turn faster. If you can reinvent your business to make inventory and other necessities self-funding, you will go a long way toward improving the transferable value of your business. Driver number 5 takes this concept even further.
Value Driver Number 5: Predicable Recurring Revenue is King
Some businesses get paid whether they provide a service or not. Have you ever had a gym membership? Don’t think this couldn't apply to you. Have you ever received a gift card that you promptly lost or didn’t completely use up? How about a maintenance contract, unlimited support, automatic upgrades, routine inspections, etc.? Chances are you are paying someone else for several of these services right now. Think about how your business could automatically charge a customer’s credit card for something every month until they take the initiative to cancel. Start selling that as an add-on to whatever you normally provide and you will not only supercharge your margins, you will make your business much more desirable and valuable in the process.
Value Driver Number 6: Position Your Business or Product as Unique and Different
Something that could be bought from many places is a commodity. The idea here is to differentiate yourself from your peers and competitors so that you do not have to charge what they charge. The most valuable businesses have control over their pricing and charge what they need to charge to remain healthy and profitable. Businesses that must charge “the going rate” are harder to make stand out because in most sectors, “the going rate” is normally “a range.” And at the very least, you want to build your brand and reputation to the point where you can be at the high end of the range and seen as worth it. You might focus on speed of delivery, exceptional customer service, white labeling, or any of a myriad of other strategies to command a higher price. Make it happen – this is important!
Value Driver Number 7: Customer Satisfaction
We have an assessment on our website that we encourage business owners to take. The assessment is geared towards revealing where your business ranks in these 8 categories, and it baffles me that 99.9% of business owners have a perfect or near perfect score when it comes to customer satisfaction. It highlights the owner’s bias, and herein lies the issue with most business owners. They “think” the business is better or more valuable than buyers do. Think of a great business. (One that is not the one you own.) Would you believe they have 99.9% customer satisfaction? If you have a lot of transactions, you will do well to get an unbiased third-party measurement of your customer satisfaction. Proving to a buyer what the market thinks of your business can go a long way towards their comfort level. And if you measure customer satisfaction and do not like the result, it will give you something meaningful to work on where any improvement will strengthen valuation.
Value Driver Number 8: Owner Dependence (a Two-Edged Sword)
There is no question that knowing everything that goes on in your business and being involved throughout keeps you in control and mitigates things getting offtrack from the way you want them to be. However, when you go to sell a business that operates like that, how is the buyer expected to replace the all-knowing, sole decision-maker, king of the castle? To build a truly lasting, truly transferable, truly valuable business, you need to hire, train, and trust key managers and decision-making staff. Without them staying with the business after a sale, there’s truly little transferable value. In fact, businesses that are absentee-owned are highly desirable due to the fact that the owner can extract predictable cash flow from an operation that takes little to none of their time. Bottom line: the less dependent the business is on you (for the day-to-day work and routine decisions), the healthier your organization will be, and the easier it will be for a buyer to envision sustained results in your absence.
Remember, value is established by the buyer, not the seller. And while private company business valuations rely on a multitude of factors, it is never too soon to begin managing your business with valuation in mind. When it comes time to sell your business, get prepared to defend your opinion of the value by using these trends and metrics to prove your case.
Gilbert & Pardue Business Advisors (GaP) is a Houston-based business advisory firm serving lower middle market and middle market business owners from coast to coast through representation for Mergers & Acquisitions (M&A) and through business value-growth services such as Fractional CFO, Advisory Board, Executive Coaching, and Consulting.
Matt Gilbert and Bret Pardue established GaP to provide owners of businesses generally enjoying annual revenue of $5-$75 million with the quality of M&A representation and value-enhancement services previously only available to upper middle and large businesses. GaP brings highly-experienced executives, sophisticated financial and marketing products, proven-effective processes, and fully-integrated expertise to every engagement. No other M&A firm serving the lower middle and middle market provides the quality of representation and transactional expertise that we do.