The centuries-old phrase about the value of something only being “what someone is willing to pay for it” is a proven economic fact, especially in business. Many a family-owned business has been shocked into reality when company history, brand or location sentimentality and sweat equity count for nothing when it comes time to sell, take on investors, or retire.
How can you tell, ahead of time, what “someone is willing to pay” for your business? The gauges are many and, depending on the source, there can be as few as four or as many as a dozen key drivers of value. Across that range, the recommended activities to drive business value basically fall into two buckets: tactical and strategic. Advice around tactical value drivers includes things like “set a win-win price”, “focus on your most valued customers” and “identify the customers and segments where you can create more value relative to competitors”. Presumably, elements like these fuel your on-the-ground marketing strategy and allow your business to grow in both revenue and profits.
The strategic value drivers are more programmatic, systemic processes that are broader in scope and take more coordination and effort to accomplish. The pillars of business performance like “Recurring Revenue”, “Growth Potential” and “Customer Satisfaction” are among those most often cited as critical for driving company value.
Customer base diversification is a big value driver that often sneaks up on business owners. “Buyers typically look for a customer base in which no single client accounts for more than 8-10% of total sales. A diversified customer base insulates your company from the loss of a major customer.” In one example, published by Forbes, a business with a high concentration of their business in the hands of a small selection of clients sold at far lower than the expected price. “When the business finally did sell, the buyer demanded a 35% hold-back and a purchase price reduction if more than one of the five largest customers left within 30 months of purchase. The purchase price multiple was at least 20% below the investment banker’s expectation – due to the risk buyers perceived.”
Called the “Switzerland Structure” within the popular model of The ValueBuilder System™, companies are measured on how dependent the business is on any one employee, customer or supplier to determine how they compare to industry averages. “Many companies know, in general, the key issues that drive their business, but the advantage comes in knowing how your company measures up against industry norms,” mentions Dr. Kiu Leung, executive coaching and forums leader for Renaissance Executive Forums in Madison, Wisconsin. “Using a tool like The ValueBuilder System™, which compares metrics from more than 45,000 companies, you can see where your company compares favorably against your competitors, and where you have more work to do to stay abreast of industry performance levels.”
Being able to identify challenge areas in order to at least improve to average levels across a given industry allows companies to avoid hold-backs and undervaluation when it comes time to estimate value. The ValueBuilder System™ provides a dashboard score for companies to see how they compare to industry standards across a number of metrics including growth potential, financial performance, recurring revenue and customer satisfaction. As a barometer for business valuation, it’s a quick and easy look at where your company excels and where you fall short of your peers, which is invaluable when you’re negotiating. Real estate agents and mortgage companies do it all the time: canvassing the area for comparable homes to establish an average value. Buyers target the “below average” opportunities for discount offers, and sellers who want to sell at premium prices make sure that compare at above average levels.
“For companies that just want to know where they stand, financially speaking, and what their multiples might be if they were looking to sell, The ValueBuilder Score is a quick and easy way to ballpark that,” adds Leung. “You can establish a baseline and then, with concentrated effort, track and monetize improvements in that score over time. The average company is sold for a multiple of 3.66. For companies who score higher than 80 on The ValueBuilder Score, the multiple escalates to 6.1 and results in a 71% premium on the sale price.” If company valuation is a race, The ValueBuilder Score acts as your speedometer as you jockey for position against other cars.
It’s important to remember that nobody’s perfect. It’s rare that a business outperforms in every category across the value drivers. However, all of the value drivers – whether tactical or strategic – are focused on increasing cash flow, and if cash flow is increasing year over year you’re on the right track. Having visibility into areas of challenge, especially as compared to others in your same industry, allows you some targeted shortcuts on what needs work.
“Selecting the best strategies and incorporating them into your growth plan is critical for the ultimate success of your Exit Plan,” writes Forbes contributor John Brown. “Ask your advisors, fellow owners or an Exit Planning advisor which strategies are the most appropriate for your company.”
For CEOs and business owners who are interested in digging deeper and conferring with peers about value drivers and how to increase the value of their companies, the upcoming CEO Learning Session: The Path to Higher Profitability in 2019: 8 Key Factors will focus, in part, on that topic. The CEO Learning Session is being held in Madison, WI on January 15, 2019 at the Fluno Center.