Business Value Drivers

3 08 2012

Business value drivers are those aspects of a business that can and do add value.

Today’s business environment is not just about survival, it’s about focusing on and creating sustainable value. But, which elements of a business are capable of creating value? Equally important which elements of a business are capable of destroying value? Proper business planning is the process of uncovering and identifying what creates and drives value.

ImageStart by using the SWOT Analysis – Strengths, Weaknesses, Opportunities and Threats – this will help you identify the “value drivers” for your business. With this approach, you can focus on key value drivers.

There are many Value Drivers that have been identified in businesses. But, typically no more than 8-12 are critical in any given business; here are the most common 8.

 

 

Financial History:  

Are your books accurate and up to date? Over the last few years are there patterns of growth or decline? If in decline, are there good reasons for the decline?  Accurate and current financials are important to determine how the company fares in its industry and amongst competitors.  A comparison to industry ratios can identify strengths and weaknesses in the business.

 

Management Depth:

Can the company operate without the owner, for more than a week or two? Is there any cross-trained management to fill in if you were gone?  What is the average age of management?  Will they retire soon? What levels of experience and education do they possess? Having a good management team can add value to the business.

Customer Diversity:

Do you have one or two major customers that account for more than 25% of your gross sales?  What would happen to the value of your company if you lost one? Are most of your customers considered “blue chip”? A good overview and a rating analysis of the customer base can be beneficial not only for added value but is crucial for where, how and when you advertise, not to mention a much better understanding of your accounts receivable and aging.

 

Owner Involvement:

Are you the ‘rainmaker’ in the business? Does everything from sales to

production revolve around you and your decisions? How difficult would you be to replace? The more the business depends on you, the owner, the more likely the value will be lowered.  One of the things I see the most is that over the years, the business owner and number one sales person, is now an office manager.  Maybe it’s time to get back out in the field with your sales people or provide on-going sales training.

Competition:

Does your company compete in a clearly defined market niche which is

defensible? Or, have your products or services become a commodity that is becoming more difficult to defend?

Customer Satisfaction:  

Are your customer relationships based on great products and service, or lowest price? How long and what type of history have they had with you? Are they satisfied or loyal? Do you have systems in place to identify your customers and communicate.

Loyal Employees:

Outside of ownership, are there people in place who you can rely on and are

capable of doing their job day in and day out? Are they considered knowledgeable for your industry? Again, what levels of experience and education do they possess?

What is the average length of employment amongst your staff? A responsible business buyer will be looking for opportunities where the current staff, especially management, will remain in place, following the current owner’s exit from the business. Having key employee contracts, non-competes, but more importantly a loyal, dedicated staff that is committed to the company’s success regardless of ownership change will be highly valuable to a prospective buyer and thus reflected in a business valuation.

 

Proprietary Technology:

Has your company developed a unique application, tool or technology as part of its

Ongoing operations? Does it give you a competitive advantage? If so, this proprietary innovation or intellectual property can be positioned as a key value driver for your business. Technologies or processes do not have to be patented to carry value but privacy and confidentiality must be maintained. It is critical that non-compete and confidentiality agreements be strictly adhered to and enforced by the company, before and after a transfer of ownership. The benefits, application and purpose of your proprietary technology should be explained to a business valuation consultant.

Intangibles (intellectual property) and human resources (who go home at night) can be protected and leveraged through a combination of business strategies and legal protections. Business strategies include incentive compensation plans to recognize, reward and retain high performing employees. Legal protections include requiring key employees to sign non-compete agreements, registering Trademarks and Copyrights, and taking steps to protect proprietary information/trade secrets such as recipes and formulas. Contracts with key players, including partners, customers and suppliers, are also important.

In conclusion, it’s easy to be distracted by all the demands competing for the business owner’s time and attention. To maximize the value and profitability of your company, you need to focus on the key value drivers – which may be intangibles and employees – in addition to having up-to-date equipment and systems.

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Comparing Comparables

3 08 2012

Comparing Comparables 

By: George D. Abraham CEO & Chief AppraiserImage

Business Evaluation Systems  

The Direct Market Data Method (DMDM) relies on the principle of substitution. A buyer will not pay more than the price at which he can obtain an equally desirable substitute.

 

The DMDM method uses parameters of comparison in the form of income multipliers.  They can be multipliers of income, either gross net or discretionary cash flow.  The three most popular databases which supply the transactional data are; Institute of Business Appraisers (IBA), BizComps and Pratts Stats.

 

When attempting to value a company using the Direct Market Data Method (DMDM), it is not uncommon to experience a wide range in value between the Price to Discretionary Earnings (P/E) and Price to Sales (P/S). In using the transactional data, one must remember that we are comparing businesses and in most cases, these are complex entities.  Unlike real estate, whereby land and improvements can be measured fairly accurately using a comparison of price per square foot, businesses are much more complex and have many variables that can have a significant impact on value. There are several reasons for the wide ranges that occur between the two multiples when using the databases.

 

The three databases obtain their data mainly from business brokers and other intermediaries.  The reporting systems for each of the databases are not standardized and some are limited regarding details of the transactions. The fundamental problem in collecting data is the reporting forms supplied to collect the data.  Business sale structures can be very complex, forcing the broker to elaborate on the form in order to describe the input, especially when it comes to the selling price.  Many sales contain exchanges, earn-outs or an additional price based on some contingency and forces the business broker to elaborate when the reporting the selling price of the business. The person inputting the data into the database is faced with deciding the selling price.   Unfortunately, the industry lacks consistency in common terms such as owner’s discretionary cash flow and net income (before or after tax).  The BizComps database removes the inventory from the selling price, but many times sales include inventory and is not mentioned or if mentioned, no inventory value is given.  Inventory values given to the other databases and included in the price, have usually not been valued or even counted for accuracy. In my experience, the Sellers value of the inventory is almost always incorrect as it does not include adjustments for slow moving, never moved or dead inventory. Adding to the dilemma on inventory is FIFO and LIFO accounting.

 

The sales contained in the databases were sold as asset sales and generally do not include current assets or liabilities, but many times to make the sale, the owner will include the receivables and/or allow the buyer to assume some of the liabilities.

 

Another problem with reporting the sales consistently are real estate and improvements.  Companies in the databases do not include real estate and improvements and a fair market rent has been deducted from the company’s earnings, but was the rent used really fair market?

 

Location of business is given only in terms of general geographic area which could have a significant effect on value for some businesses whereby location is paramount to success.

 

In other cases, the sales with high multiples are not arms length and the business was purchased based on acquiring a valuable location or a competitor paying over market value to eliminate a major competitor.  As many Baby Boomers are retiring, they are transferring the businesses to sons and daughters and these may also not be at arm’s length.

Another problem, which in my mind is significant, is that prior revenues and earnings are not provided. Without a history of the company’s historical performance we do not know if the Company was in rapid decline or significantly increasing in revenues and earnings. Despite the reporting problems inherent in the databases, if analyzed correctly, the data is very valuable. The least it can do is set a range of multiples that you can narrow down. 

Business appraisers will sort the sales in the databases according to revenues and then choose a group which contains sales that are close to the company or a sales range which would not change the operating ratios significantly.  Once the comparable group is established, the companies in the group need to be carefully analyzed to their closeness to the subject company.  Companies whose sales to earnings ratios are significantly different than the subject should be discarded. A close look at the location should be made if that is important and the date sold.  I think it is safe to say that most people feel that there was a world of difference in business after the beginning of 2009.  However, before you form this conclusion in your analysis, take into consideration that all values are derived from anticipated future performance.  As we all can remember, interest rates were extremely high back then and required return on investment had to compensate for this, this and the higher the return required, usually the lower the value.  Currently interest rates are at an all time low and the required return is much lower so in some cases the older sales may not be that different.