In today’s dynamic business environment, understanding the numerical value of your business is more than just a point of interest; it’s a strategic necessity. With my background in business succession planning and helping private companies identify and grow their valuations, I recognize the pivotal role that knowing your business’s value plays in achieving sustained success and growth. This knowledge influences critical aspects such as capital raising, exit planning, and strategic initiatives like hiring and product development. It’s imperative for business owners to grasp their business’s value and take steps to enhance it.
Why Does This Number Matter?
Need further persuasion? One compelling reason for business owners to ascertain the numeric value of their business is to make informed decisions. Having a clear understanding of your business’s current value enables you to establish realistic goals and make strategic choices that align with your objectives. It facilitates an assessment of your company’s financial well-being, pinpointing areas for improvement and opportunities for investment.
Plus, when you’re seeking investment, identifying needs for a capital infusion, or contemplating a sale, potential lenders, investors, and buyers will scrutinize your business’s value. A well-documented and accurately assessed business value is crucial for attracting the right investors or buyers who are willing to pay a premium for a valuable asset: your business.
Accurate valuation can also lead to more favorable terms and negotiations. For example, in our current economic landscape, banks face challenges that include debt ceilings, inflation concerns, and interest rate issues. As a result, they’ve become more cautious about selecting attractive loan candidates among small- and medium-sized businesses. Merely showcasing consistent financial performance and a strong growth story is no longer sufficient. We have seen several cases of banks now requiring a more comprehensive and detailed evaluation, emphasizing the importance of non-financial metrics and ESG (Environmental, Social, and Governance) measures.
How To Evaluate Your Business’s Value
To make this more tangible, let’s look at an example of a company we’re working with today — anonymized here as “Smith Engineering” — a mid-sized light manufacturing business in Ohio with a turnover of just under $10 million and about 35 employees. It has been family-owned for more than 40 years and has always performed well, growing consistently and banking decent profits annually. In terms of financial performance, however, it could be better.
The business has historically made between $1 million and $1.5 million for several years now, between 10-15 percent net profit on turnover. Good, but not great. Why? By comparison, looking at industry benchmarks, the best-in-class businesses in the industry will achieve better than 15 percent net profit. So, it’s evident that Smith is missing an opportunity to acquire more value.
5 Common Drivers of Business Value
- Intellectual property.
- Intangible assets.
- Export potential.
- National scalability.
- Franchising opportunities.
Benchmarking to comparable businesses and industry standards is one factor. For example, this might show that the competitors’ cost of sales is 3 to 4 percent less than Smith’s, and that could be a major cause of their lower profit.
To really have a comprehensive value assessment, owners (and their advisors) must go beyond the traditional financials and also examine key value drivers, addressing questions such as which factors contribute to your business’s value and how to enhance them. Depending on your industry, these value drivers may encompass intellectual property, intangible assets, export potential, national scalability, or franchising opportunities. Similarly, you should identify factors that diminish the business’s value, including risks, over-reliance on key personnel or potential single-person points of failure, an unstable management team, or weak systems, policies, and procedures. Understanding these dynamics allows you to identify levers for accelerating business value.
4 Common Threats to Business Value
- Marketplace/business risks.
- Over-reliance on key personnel/Potential single-person points of failure.
- An unstable management team.
- Weak systems, policies, and procedures.
Digging Into Non-Financial Aspects to Drive Value
Given that resources are finite, prioritizing which levers to pull and gauging their potential impact is crucial. For Smith, compared to the industry benchmark alone, this suggests the business could be worth upwards of $2.5 million. In looking at key value drivers and potential opportunities to improve its value, however, Smith’s valuation could balloon to $6 to $7 million at the highest end. That’s a big range; how could the same asset have a variation of $4 million? The answer, perhaps counterintuitively, lies in confronting the non-financial aspects of the business.
For Smith, the low multiple of 2.5 times profits is low because of all the risks typical of business like this. Some can’t be controlled, like economic risk (inflation, interest rates, foreign exchange, and so on). The industry also has its own set of risks. Engineering firms are competitive, the barrier to entry is low, and they’re susceptible to technological risks like automation.
Finally, we have to look at company-specific risk. This has the biggest impact in most cases, consisting of a series of risks that many small- or medium-businesses haven’t addressed, such as owner and/or key person dependence, sales/customer concentration, lack of systems and policies and procedures, lack of corporate governance, poor sales and marketing, low levels of technology and automation, poorly designed incentive and reward plans for key people, compliance with financial and non-financial regulations, financial management, budgets, cashflows, and reporting.
At Capitaliz, we actually put numerical scores and letter grades on financial and non-financial factors. Doing so can help business owners identify the areas in which they’re operating at a higher risk. A business like Smith Engineering has several poor scores in specific areas, driving down their valuation significantly.
Most owners underestimate the impact of these non-financial factors on the valuation. Entrepreneurs are naturally aggressive risk takers, focused on growth and sales; they do not naturally focus on risk and compliance, hence the impact on valuation.
Finally, no matter how far off the idea of passing the torch along might be, succession requires careful planning. Knowing your business’ value is integral to this process. It helps you determine fair equity distribution among heirs and ensures a smooth transition that minimizes conflicts. Someone who needs $4 million to pay off bank debt and retire comfortably needs to know if the business will only sell for $2.5 million present day. They have some work to do and may need to delay retirement, for example.
Value Your Business Properly to Get Where You’re Going
Understanding the numeric value of your business is not only important but also indispensable for strategic decision-making and long-term success. Remember, increasing business value is an ongoing process that requires dedication, adaptability, and a keen understanding of market dynamics. With the right strategies and a commitment to excellence, you can identify and enhance your business’s value, secure its future, and achieve your long-term goals.
