what makes a business valuable & how to make your business more valuable
What is driving you? Running a profitable business, employing a team of good people, having a good lifestyle or enjoying the fruits of your labour?
Would you like to build a valuable asset too? An asset others would want to buy. When it is time to capitalise the real money lies in selling but can you do more to make your exit more valuable?
...this is the one thing that can instantly make your business more valuable.
Ever wondered what makes one business worth more than another? What about when businesses compete in the same sector, why is one more desirable and worth more than their peers?
With over 60 years’ experience, we know a thing or two about what drives value and perhaps more importantly, what can take it away. With that in mind here is a brief guide to the factors which have an impact on business valuation. In general, these are the common characteristics, in no particular order, regularly seen in most valuable companies.
- Stable second-tier management
Is your business reliant on you? Could you go away on holiday for three weeks without calls and emails from panicked staff? Businesses with a strong, and preferably stable, second-tier management (prepared to stay on post-sale) are worth more than an enterprise reliant on its owner. Despite being obvious, this is the one thing that can instantly make your business more valuable.
Not all businesses can be scaled to the need for secondary management. Perhaps profits aren’t enough to afford the investment of a management team? It takes time to bed in a new manager, and what if they’re no good? Maybe you’re happy running a small business where you have total control?
Irrespective of your operations, not having a management team, or even a staff member who could step up to the role, puts a ceiling on what potential buyers will pay to acquire your business. A buyer doesn’t want a business where the owner is the business.
- Recurring revenue streams
A holy grail for most businesses. Recurring revenue streams, repeat contracts and subscriptions are attractive and valuable. Not all businesses and industries lend themselves to this model, but the more of this type of income you can generate, the more valuable your business will be.
The IT industry is full of examples; just think of some of the software and apps you use. Another example is the document storage sector. Imagine the thousands of boxes of papers stored for businesses all with a recurring monthly tariff.
- Long-term contracts
A long-term contract is only good for you if it is profitable, provides economies of scale or operating efficiencies. Term contracts can add value to a business. Customers are committed, and owners know they’ll have revenues to invest for the future.
- A good spread of customers – not too much concentration
What do you do? A customer keeps giving you business. It is very common for small businesses to nurture and get hooked on supplying one large customer. However, it can make your enterprise a risky proposition. Don’t have all your eggs in one basket. UK construction giant Carillion being hooked on government PFI contracts is a good example. Projects can quickly become unprofitable, and it may become very hard to pay your bills.
Buyers will pay a premium for a business with a good spread of customers. For optimum value, no one customer should represent more than 5-10% of your sales revenue.
- Efficient and accurate accounting systems
A tidy ship where you have accurate, reliable and efficient accounting systems will pay handsome dividends when it is time to sell. It’s good housekeeping too, and vital to the perception a buyer will have of your business. Imagine, a red-hot private equity firm chomping at the bit to make you an offer and all that’s stopping them is the wait for you to cobble together some management accounts which you don’t have because you’ve never needed them before. Will the buyer think you’ve got your finger on the pulse? Does it sell them on an efficient tightly controlled cash machine? Unlikely, isn’t it?
You cannot expect a premium if you can’t quantify how you’re making money and prove it in a timely fashion. Get your house in order. Sort out the paperwork and do regular management accounts.
- Loyal, long-term customers
Who doesn’t want to have happy long-term loyal customers? The ability to demonstrate that your customers will return and buy from you, again and again, makes your business valuable. If you can collect testimonials and instigate a tracking system to monitor customer satisfaction your business will benefit when it’s time to cash in.
Does your business push the boundaries of your sector? Do you have innovative, groundbreaking products or services? Utilise the latest software and look for productivity increases where you can. Perhaps some proprietary way of operating keeps you ahead of your peers. If this is the case, then it will add value.
- Location, Location, Location
If being close to your employees, suppliers and customer’s make business easy, it will attract buyers who understand your sector. I’ve sold countless businesses primarily for their location. A good location, or ‘gap in the map’ for a buyer, adds value.
- Good reputation
A business with a good reputation and in good standing in its industry will attract attention. It is not uncommon for a business to acquire a competitor for the knock-on effect of improving its image. To quote US uber-investor Warren Buffet:
“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently.”
- Cash generative
Businesses which generate cash are always valuable. Manage your debtors well and be ruthless when tying up cash in stocks and plant. Review overheads regularly and look to raise prices as soon as your costs go up.
- Growth & Expansion opportunities
One of the principal reasons for a business to acquire is to grow top and bottom line profits. If you’re outperforming your peers and growing fast in your industry, you will be attractive and valuable. The more expansion opportunities your business has, the better.
- USPs / Competitive advantage
Similar to innovation above. Does your business have any unique selling points (USPs)? Do you manufacture widgets customers can only get from you? Do you provide a service unavailable anywhere else? Buyers will look for and value things they can’t easily do or replicate themselves. If they find them in you, they’ll pay more. If everyone operates in the same way, then your business isn’t rare or different. Avoid selling as a commodity. If it isn’t unique, why pay a premium?
- Strong M&A Activity in the sector or consolidation
If merger and acquisition (M&A) activity are common in your industry, and consolidation is happening, then you can profit from good timing and be in the right place at the right time. This is hard to plan for, but if your house is in good order, you can take advantage when the opportunity comes knocking. If your sector becomes fashionable, you can bathe in the reflected value which comes from all the attention.
- Barriers to entry
I recall one client who was involved in a very basic but large-scale form of food processing. The unskilled commodity food and manual labour involved wasn’t complicated. However, it supplied a niche sector with strict regulatory controls, and needed multiple forms of international certification, accreditation and licensing just to operate. While this business could be readily replicated by any one of hundreds of businesses, getting the approvals to operate could prove difficult and complex. A simple operation, but high barriers to entry. As a result, the business had high-profit margins and plenty of suitable acquirers.
While it’s desirable for a business to have as many of the above factors as possible, there are also a few considerations for what can detract value too. Here are the most common:
- Dependence on a supplier
The same having a diversified and well-spread customer base adds value, being dependent on a single or major supplier can have risks too. Could your business be wiped out on the whim of a supplier or trend in a marketplace? Long-term contracts can help if you’re exposed, but the value goes down in line with the inherent risk.
- Vulnerable to cheap offshore labour
Globalisation has made many sectors vulnerable to offshoring. Can your profit margins survive the competition for your product or services replicated in a geographic location with lower costs? Let’s not forget the hot topic of artificial intelligence, robots and automation.
- High cost to grow and expand
Some areas of oil exploration are just too difficult and complex to enable cost-effective oil and gas extraction. Perhaps the technology doesn’t yet exist to do it, or maybe the challenges are simply too great. Do you operate in a mature industry where the cost of operating or investing is too high for the returns on offer? It might affect your value.
- High capital expenditures
Unless the returns are massive, an acquirer doesn’t want to buy a business that has to invest mountains of cash in continuing to be operational or competitive. The advent of digital printing hit many well established traditional printers who couldn’t or didn’t invest in expensive new plant and technology to enable them to remain competitive in the sector.
- High fixed costs
Sky high rents or premises costs, staff, licensing, vulnerable commodity prices etc. can all affect the attractiveness of acquiring a business. Are there any areas in your business where overheads can be trimmed or efficiencies identified?
- Too many competitors
Niche is good as nobody wants to play in the field with too many competitors. We are regularly told that competition is great for consumers, but it rarely is for suppliers and producers. Once a market becomes commoditised then price, and scale becomes the driving force. A dangerous place to be as profit margins could move on to thin ice.
“The successful man is the one who finds out what is the matter with his business before his competitors do.”
Roy L Smith 1955
There are of course many other factors and individual circumstances which can increase or decrease the value of your business. Having an independent, confidential and professional valuation which identifies what makes you valuable and why is a powerful first step to gaining insight and knowledge to help you with your business goals and aspirations.
It is said that knowledge is power, but you can’t manage and improve what you can’t and don’t measure. After all, knowing what you’re worth should be as important as what is in your bank. Start your valuation today, now.
I’d be delighted to help you and answer any queries you might have. Please call me directly on 01225 460 777 or fill out this simple form below.
I look forward to talking with you.