When a business owner looks to increase the value of their company, they typically go after the low hanging fruit such as increasing sales, cutting costs, or improving margins. These are absolutely valid ways to increase value but only represent half of the valuation equation.
The value of a business, in its most simplistic form, is the company’s ability to produce future cash flows divided by risk. The inverse of risk is the multiple, which explains why M&A transactions are typically based on EBITDA (cash flows) multiplied by a multiple. As a result, the higher the cash flows, the higher the value. Likewise, the lower the risk, the higher the value (or the higher the multiple).
In this article we are going to discuss five ways to increase the value of a business, which are not necessarily top-line oriented, but geared to increase future revenues or reduce risks related to the business.
1. Management Team. It is very common for mid-sized businesses to be too dependent on the owner for their success. In many cases the owner may be in charge of operations, be responsible for most customer relationships, and hold the know-how behind their brand or technology. In these cases, the value is not within the business, but instead the value is within the owner themself. In order to mitigate the risk of having too many critical aspects of a business depend on the owner, business owners should look to develop or hire a management team to take the lead on the various aspects of growing a valuable organization.
Additionally, the development of management is typically one of the first steps in enhancing business value and serves as a launching point for a couple of the items listed below (de-risking and scaling the business).
2. De-Risking. As previously mentioned, reducing risk is a key aspect to increasing value, and becoming less dependent on the owner helps accomplish this. However, there are many other ways to lower the risk to future cash flows, and these generally involve anywhere there is a concentration, such as: 1) customer concentrations, 2) vendors concentrations, 3) supply chain concentrations, 4) product or project concentrations, and 5) geographical concentrations.
Many businesses felt the financial pain caused by the supply chain concentration during the height of the COVID-19 shutdown, which in some cases has not been completely resolved. Accordingly, potential buyers or investors are also not willing to pay top dollar for businesses that contain concentrations of risk.
3. Demonstrate Scalability. A scalable business is one that can support continuous growth and will not be hampered by its own limitations. Scalable growth also allows businesses to improve profit margins as revenues increase. Scalability can be portrayed by developing a management team (as previously discussed) but fundamentally scalability is demonstrated with a strong business foundation. A strong foundation will translate to a potentially better or larger business that it can support. Depending on the type of business or industry, the composition of the foundation may vary but examples include:
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- Management team
- Employee teams (outside of management)
- Equipment/facilities
- Technology
- Know how
- Processes
For a business to portray scalability, the elements which comprise a company’s foundation should contain a capacity level beyond its current needs. This serves as a reminder that investment into scalability precedes actual growth.
4. Financial Reporting Strength. A key attribute in achieving maximum value in a business is being able to substantiate that the company is indeed highly profitable. This attribute may be one of the more underrated and underappreciated aspects among mid-sized businesses. Having a robust financial reporting system in place will help the management team and owner understand patterns, strengths, and weaknesses, and plan for future initiatives with greater accuracy and confidence.
In addition to the current operating benefits, if the company were to ever go through a sale, it is its financial reporting that will ultimately give the buyer the comfort that the cash flows and profitability purported by the seller are accurate. It is not uncommon for deals to fall apart due to insufficient financial information, which leads to the potential buyer’s lack of confidence in the profitability levels originally communicated to them.
5. Branding and Name Recognition. It is safe to say that businesses that have developed a strong market brand are more valuable. The intangible value from branding commands a higher price tag than value generated solely by equipment or services (tangible value). Brand recognition can be developed in many ways depending on the industry and type of business. In some cases, it is built by providing value-added services which creates visibility in the marketplace. In other cases, brand recognition is enhanced by investing in marketing efforts.
Taking the time to address the above points provides the opportunity to maximize the valuation upon a sale or similar transaction. Additionally, these topics represent good old-fashioned business practices and increase future cash flows to current ownership. If you would like to learn more about ways to increase the value of your company, please contact us.