Factors that Increase or Decrease Business Value
By: George D. Abraham
CEO & Chief Appraiser
Business Evaluation Systems
There’s a range of key factors that can affect the value of a business. While some of these factors are outside of the owner’s control, steps can be taken to make the business as valuable as possible. Start planning well in advance and consider inserting an exit strategy into your original business plan. Then start implementing the factors that increase value and eliminate the factors that decrease the value.
Just how good are your financials. Are they minimal or do they show an in-depth look at your business. Can you easily track the flow of revenue and expenses flowing from the invoice to the financials to the tax returns? Can your track the sales of your top 5 customers? Can you easily prove all of the perks you receive from the company? Today’s accounting software easily lets you do all of this and much more. When a buyer is interested in a company, the ease at which the owner can prove the financial performance of his or her business has a direct impact on value. Incomplete or inaccurate financials tells the buyer that no one is watching and tracking the Company’s performance and therefore the future performance (of real importance to the buyer) is unpredictable. Value is created or destroyed by the ability to see the Company’s future. The longer the buyer can see that the Company will perform in the future as represented, the more secure they are and less risk is perceived. To the contrary, when the future is a guess, risk is increased and value is decreased.
Obviously, small increases in revenues over the year’s shows a different picture than equally decreasing sales and the same is true with large increases and decreases. The key to value is the owner’s ability to explain the precise reason. Many times declining sales, if explained does not affect value as negatively as one might expect. Retiring doctors decide to work less, firing unprofitable customers and price increases that result in increased earnings do not impact the value of the business as negatively as one may think. Again, the key is the explanation of why revenues and/or earnings have dropped.
The big question is what would happen to the business if ownership changed. Obviously, if the Company’s management and sales department are you, the owner, expect a decrease. On the other hand, if the sales are made by the sales department and the Company has department managers that report to the owner, value increases. Another factor is the longevity of the management team and in general all of the employees. Have the managers and employees been with the Company for several years, or is constant turnover the norm? These people have key knowledge of the internal workings of the Company, products and services and relationships with suppliers and customers. A well trained (and cross trained) knowledgeable management team and employees with longevity greatly reduces risk to the hypothetical buyer and thus increases value.
When you look at your operation, do you see a busy, organized facility with well maintained equipment? A facility that is busy, appears to be unorganized, with dirty equipment, reflects the same image for the management and employees. Well maintained, clean equipment and vehicles tells the buyer that regular service and good maintenance records are the norm and this increases value. The opposite portrays, short lived equipment and vehicles with higher amounts of capital expenditures in the future that reduce earnings and lowers value. One has to imagine that the kind of appearance the Company has, may represent the kind of customers it has.
First impressions are important! A clean organized business with well maintained assets and good financials portrays a good well managed, solid business and reduces the risk level in buyers. It reduces the depth of the financial due diligence process, questioning asset and inventory values and creates a more secure atmosphere for the buyer.
Good financials, formalized business and marketing plans, well trained and knowledgeable management and employees with longevity add up to value.
Competition is always a risk to a buyer. The more you know about your competitors and why they will not affect you is extremely important to a buyer. If your company has intellectual property, valued or not, be able to explain (even better to calculate it) the advantages your company derives from it. Start an exit plan a couple of years in advance, to address any of these factors that may pertain to your business. A business owner that knows the strengths of his or her business and can reasonably prove it, has a large effect on the appraiser and the buyer.