Beauty is in the eye of the beholder, and the same is often true of a business’s value. Short of being able to read someone’s mind, there are a number of factors that you can consider to determine how appealing your business is to a potential buyer or investor to create value.
The value of any business or asset is driven by the future cash flow that can be generated, and the risk associated with generating that cash flow.
The hardest element to achieve is the cash flow of the business and rightly this does get the most attention from business owners. However, it is important to note that when someone looks at the value of your business, they won’t just look at the most recent year but will look at the past trends and your forecast results.
Investors will also look at unusual items such as one-off expenditure or revenue. Obvious items for smaller companies are private expenditure that has been incurred through the business (or not) and how owners are remunerated. For example, are owners receiving a market salary for their contribution to the business or are the business profits artificially inflated? These types of adjustments are considered in determining a normalised earnings position for the business. This will form the base position of any valuation of your business.
How trading activity converts to cash through the timely collection of debtors, and managing the payment of creditors, is often neglected and can impact valuations. It is worthwhile to ask yourself, are there steps that can be taken to improve cash collections? Can the payment of suppliers be managed better and delayed? Improvement in these areas does improve value.
Another factor to consider is capital expenditure requirements. It is a false economy to defer required investment, as anyone considering acquiring or investing in your business will look at this, the potential impact on your future earnings and therefore your value.
The risk of the industry you operate in is reflected in the value of peer companies in the sector relative to their profitability. How your business relates to the market will identify specific risk for your business and matters that you may be able to improve. For example, how your operating margins compare, and historical and expected growth in revenue compared, to the peer companies means that your business should trade either higher or lower than the companies identified.
Smaller private companies are inherently riskier than listed companies for which market data is available and their valuations reflect this higher risk.
If you hold shares in a listed company, generally it is very easy to sell the shares that you hold quickly to convert the value to cash. It is much harder and more expensive to sell all of the shares of a small private company. Given the higher risk of being able to sell the shares in a private company, a buyer will pay less to compensate for the higher risk being taken.
For a smaller company; the impact of the loss of an important customer or member of management is more significant. There is also generally reliance on key staff members. Having a management team in place to reduce the reliance on the owners, succession planning to cover key positions and activities are all actions over the longer term that can improve your valuation.
How you plan to realise your value is also important. If someone is buying your entire business compared to a small shareholding that has little influence over the company, you will receive a premium. Planning ahead and knowing who your potential buyers are, driving your business to make it strategically important to identified buyers, can generate a higher premium due to the strategic importance those buyers may place on acquiring your business.
Making changes to improve your businesses value will take time. It is important to have a longer-term view of what you want to achieve from your business and how you want to realise its value to ensure that you position the business in the best way to maximise value.
If you are interested in learning more about how your decisions impact the value of your business or would like to know how much your business is worth, please get in touch with us to organise a consultation.