In this troubled economy, it is more important than ever to watch your bottom line. With shrinking revenue levels and expenses on the rise, most business owners are left with the same question; what has this done to the value of my business and how can I increase its value?
A key aspect of running a successful business is knowing your industry. From sales trends and emerging markets to industry trends and regulations, staying up-to-date on the happenings in your industry will serve your business well. It is not uncommon to see business owners using multiples, obtained from the sale of similar businesses or industry averages, to value their own business. Though this might seem to be a cost effective way to obtain the value of your business, in the end it could cost you considerably.
A business is nothing more than another form of investment. Though many business owners have a sentimental attachment to the company that they have built from the ground up, the typical acquirer only cares about one thing and that is the return on their investment. As with any investment, the higher the risk the higher the return required, and the same holds true for an investment in most businesses. The more attractive you can make your business to the acquirer, the better chance you will receive a higher value. So you may be asking yourself, how can I make my business more attractive to potential acquirers?
The following is a list of key areas that play a large role in maximizing the value of your company:
- Cash Flow—Cash flows are one of the main components used to place a value on a company. A solid cash flow base with an upward trend helps the acquirer feel comfortable with the investment. Items such as spikes in cash flows, volatile swings in earnings, decreasing earnings trends, and even negative earnings make acquirers cautious and investigate further into the operations of your company.
- Forecasts—As stated previously, businesses are another form of an investment and acquirers are only interested in how much of a return their potential investment can produce. This is why financial forecasts are so important. A proper financial forecast is an incentive to the acquirer. A forecast allows the acquirer to obtain a better understanding of the future operations of the company. This is particularly important if the business foresees a change in operations from what has historically taken place. The forecasts should extend to a point in time where earnings are smoothed and stable.
- Depth of Management—There is a saying out there which states “surround yourself with people smarter than you”. This saying has never been truer than with depth of management. An individual who is looking to acquire your business may or may not be an expert in the industry. This individual will have the option to retain the employees of the company and look to them for guidance. Again, the objective of the investor is to maximize the return of his investment. A deep management pool insures that there will be sufficient resources the investor can tap into for industry expertise.
- Importance of Key Personnel—A business can become a very sentimental object to a business owner. This sentiment can also turn into a liability for the business owner if carried to extreme measures. Accrediting the success of a business to one individual is similar to investing all of your money on one stock. This investment can go up or down in a moment’s notice and potentially wipe out your total investment. By spreading the responsibilities of key aspects of the company among several individuals, you mitigate the chances of a significant loss.
- Diversification of Product Line—Similar to the importance of key personnel, diversification of product line focuses on diversification of products your business offers. By diversifying your product line, up to a point, you decrease your chances of suddenly finding your company worth far less than expected.
- Diversification of Customer Base—As with the diversification of product line, catering your business to one classification of customer will increase the risk of your company. Customer purchases are frequently based on things such as traditions, fads, and status. These factors can change quicker than the average business can adapt, leading to a decrease in sales and a less optimistic outlook. By diversifying the product line, a business owner is able to attract different types of customers, in-turn reducing the risk associated with a narrow customer base.
- Diversification/Stability of Suppliers—Suppliers are a key aspect to the wellbeing of a company. From your local corner market to multinational companies, suppliers are what keep the sales of companies like Wal-Mart alive. Wal-Mart utilizes a multitude of suppliers to maintain a stocked store and to also maintain is diversification and stability of the products sold. For smaller companies such as the local rug store, who receives all of their rugs from one vendor, the diversification of suppliers is extremely important. If this supplier were to ever decide to cease supplying the local rug store with inventory, the results could be devastating.
- Geographic Location—You’ve heard the saying “location, location, location”, and nothing could be more true. Have you ever been driving down the road and notice that at a particular intersection each corner is taken up by a gas station? Have you also ever noticed that in most cases one of the gas stations seems to be out -performing the other or maybe one station has been closed down entirely? This is one of many examples of location, though it can also extend into the company’s location near major cities or rural communities.
- Barriers to Entry—Barriers to entry are an important factor affecting businesses around the nation. I recently valued a pallet company who build standard and custom pallets for their many customers. One key aspect considered in the valuation of this company was the fact that the barriers to entry were low. Individuals referred to as “pallet gypsies” were able to start up their own pallet companies out of locations such as their garage. The pallets produced by these pallet gypsies might not meet the high quality standards produced by the valued company, however, in times of economic distress many suppliers look for ways to cut costs. Unfortunately many business owners have one requirement in place for the pallets they purchase and that is that they support the product placed on them. As long as this minimum requirement is met, many customers will shop for the lowest cost pallet.
I have always liked to relate business valuation to having your home appraised. When you have your home appraised, the appraiser searches a listing of comparables to gain an understanding of what houses similar to yours are selling for in the area. If their job were to end at this point then everyone’s house would be worth the same amount per square foot, no matter how many improvements have been made to the property. However, the appraiser typically questions you on the improvements you have made to your home to gauge what premium or discount are applicable to your specific house. The same holds true for business valuation. Attention needs to be paid to the specific details related only to your company because it is these details that have the potential to put extra cash in your pocket.
Matt Stelzman is an Accredited Valuation Analyst (AVA) and Certified Forensic Financial Analyst (CFFA) designated by the National Association of Certified Valuation Analysts. Matt has over 10 years of experience in business valuation and litigation support services. Matt works in the Specialized Services Group of Henderson Hutcherson & McCullough, PLLC. For more information visit their website at www.hhmcpas.com or call Matt directly at 423 702-8147.