Business Value Drivers
Business experts may mention "Value Drivers" as if everyone knows what they are, how they work, and where their impact will be greatest. It can be difficult or frustrating to know that building business value is a frequent topic of discussion, but actually building value is sometimes easier said than done.
It may be the case that one business has buyers lined up willing to pay top dollar while another sits on the market for months or even years. What do buyers look for in a prospective business acquisition?
There are many opinions about which attributes or characteristics buyers seek, but here’s what we have observed: The characteristics buyers seek must exist before the sale process even begins, and it is your job as the owner to create value within your business prior to the sale. We call characteristics that impact value “Value Drivers.”
As you read through the following list, remember that it contains only “generic” Value Drivers. Depending on what your company does, it may have other factors that create and increase transferable value. Additionally, there’s no particular order to this list, except for the importance of the management team: It is management that creates, manages, and grows these essential business characteristics, which is why establishing a best-in-class management team is always the most important factor of creating transferable value.
Common Value Drivers
A stable, motivated management team that stays after the owner leaves.
Operating systems that improve the sustainability of cash flows.
A solid, diversified customer base.
Recurring revenue.
Sustainable revenue, resistant to “commoditization.”
A competitive advantage.
A documented and proven growth strategy.
A demonstrated and successful acquisition strategy.
Financial foresight and controls.
Good and improving cash flow.
Scalability.
To grasp the importance of Value Drivers when preparing to sell a business, owners must put themselves in the buyer’s shoes. Consider the following case study, which illustrates how a buyer might approach the search for effective Value Drivers.
The Alpha Company has earnings before interest, taxes, depreciation, and amortization (EBITDA) of $2 million, an owner who runs the business, and systems and processes that create growth. The Alpha Company does not have a true management team in place, and the owner generates a majority of its sales. The owner is the locus of the company, holding both the CEO and CFO positions. With such overwhelming responsibilities, the owner is burning-out quickly.
By comparison, the Beta Company has EBITDA of $2 million and a solid management team that runs the business, systems, and processes. The management team creates efficiencies within the business, and the owner vacations for six weeks a year.
If you were a buyer comparing these two companies, which factors would you consider more likely to lead to a successful acquisition? How much more would you pay for a business with a strong management team (one of the most important Value Drivers)? Would you be interested in buying a business whose management team (i.e., the owner) walks out when you walk in?
Let’s look at the Value Drivers in a bit more detail.
A stable, motivated management team that stays after the business owner leaves. If you plan to take any Exit Path other than liquidation, capable management is indispensable. Having best- in-class management is the surest way to become a best-in-class company. Capable management is what buyers buy when owners sell their businesses, so establishing the best possible management team will make it more likely for you to receive the best possible price for your business.
Operating systems that improve the sustainability of cash flows. The establishment and documentation of standard procedures and systems demonstrate to a buyer that the business can maintain profitability after the sale.
A solid, diversified customer base. Buyers typically look for a customer base in which no single client accounts for more than 10% of total sales. A diversified customer base helps insulate a company against the loss of any single customer.
Recurring revenue. As a buyer, wouldn’t you want to acquire a business that prints money with the push of a button? Recurring revenue is that button that buyers look for in purchasing a business. Without recurring revenue, you may struggle to find a buyer who is willing to pay top dollar for your business.
Sustainable revenue. Buyers look for revenue streams that continue despite fluctuations in the economy. They also prefer those that are resistant to “commoditization,” which is when a company, product, or good loses its distinctive attribute, forcing that company, product, or good to compete based on price alone, which leads to slimmer margins.
A competitive advantage. To paraphrase Michael Porter of Harvard Business School, competitive advantage is a product or service that a company offers that, over time, performs either better or more cheaply than its competitors. Your company’s competitive advantage is the reason your customers buy from you instead of your competitors. Thus, having a strong competitive advantage can differentiate you from the rest of the pack, and if that differentiation is positive, buyers will be more likely to pay top dollar for it.
A documented and proven growth strategy. Even if you expect to retire tomorrow, it makes sense to have a written plan describing future growth and how that growth will be achieved based on industry dynamics; increased demand for the company’s products; new product lines; market plans; growth through acquisition; expansion through augmenting territory, product lines, and manufacturing capacity; and so on. This detailed growth plan, properly communicated, will help attract buyers. Buyers will give credence to your current growth plan if previous plans have achieved their goals.
A demonstrated and successful acquisition strategy. When applicable, having a demonstrated and successful acquisition strategy can go a long way in proving your company’s commitment to detail and wise investment.
Financial foresight and controls. Effective financial controls protect company assets and support the claim that a company is consistently profitable.
Good and improving cash flow. Ultimately, all Value Drivers contribute to stable and predictable cash flow. You can begin increasing cash flow today by simply focusing on ways to operate your business more efficiently by increasing productivity and decreasing costs.
Scalability. Could your company improve its profit margin if it increased its revenue? Considering value-added services or even creating a mobile app can contribute to the company’s scalability.
Whether interested in selling in the near future, or not, it makes eminent good sense for owners to concentrate on those elements of their businesses that create more cash flow, more sustainability, and more future value (aka value drivers). After all, isn’t this why you are in business?
If you’d like to discuss the plausibility and challenges of a third-party sale for your business, please contact us today.
The information contained in this article is general in nature and is not legal, tax or financial advice. For information regarding your particular situation, contact an attorney or a tax or financial professional. The information in this newsletter is provided with the understanding that it does not render legal, accounting, tax or financial advice. In specific cases, clients should consult their legal, accounting, tax or financial professional. This article is not intended to give advice or to represent our firm as being qualified to give advice in all areas of professional services. Exit Planning is a discipline that typically requires the collaboration of multiple professional advisors. To the extent that our firm does not have the expertise required on a particular matter, we will always work closely with you to help you gain access to the resources and professional advice that you need.