Business valuation is the process that determines the economic value of a business unit or a company. Business owners get business valuations for many reasons, such as tax planning, estate planning, exit/entry of a partner, sale value, etc. A professional business valuation is admissible in a court of law to provide proof of the company’s worth in litigation.
Because financial statements with a depreciating schedule do not show the true value of those assets, a periodic business valuation giving the accurate value of assets helps business owners make better strategic decisions.
An accurate understanding of assets helps business owners purchase appropriate insurance coverage to protect them and understand how much to sell them for in case of liquidation.
What Does Your Business Valuation Mean?
A business valuation reveals the current market value (CMV) that you, as a business owner, would likely receive if you sold your company today. So, do not get discouraged if your valuation is not what you expected. This is where value creation comes in.
The CMV is rarely enough for business owners to exit successfully. Experts advise business owners to start the exit planning process well in advance of the actual exit event (preferably five to seven years).
However, every exit is different, as is every owner’s situation. Take guidance from professional advisors regarding your unique exit situation.
What to Do If Your Business Valuation Figure Was Not What You Expected
If your business valuation falls short of expectations, value creation is the remedy. This includes:
- Identifying the company’s strengths and weaknesses
- Making a plan for value creation
- Creating value.
Identify Strengths and Weaknesses
Your business needs to create sufficient value before you can exit comfortably. Business owners often have an inflated idea of their business’ value due to their attachment to it and find accepting the accurate valuation of their businesses difficult.
Exit planning advisors can help business owners come to terms with the true value of their business by identifying the value gap that must be closed for the owner to achieve their exit goals. A value gap is a difference between the desired value needed to exit and the company’s CMV. Value gap details help business owners identify the strengths and weaknesses of their companies.
Most Common Weaknesses
A lack of documented processes and policies impedes ownership transition due to new management facing difficulties in running the business and too much key-person dependency.
Buyers see customer concentration as a risk. Customer concentration happens when 60 to 70 percent of a company’s revenue comes from the top five to seven customers. Buyers/investors fear losing valuable customers and their business post-transition and do not view such companies as good targets.
Fluctuating income makes a target company less desirable to buyers/investors because it’s tough to forecast future income based on the fluctuating records of past income.
Unfavorable market conditions, leading to low demand for the company’s products and services, destroy business value.
Lack of scalability adversely impacts business value. Investors prefer easily scalable businesses.
A company with low brand awareness has few customers and a low market share. Poor marketing and branding destroy business value. A company needs to build a loyal customer base and ensure recurring revenue for a better valuation.
In-house production with no internal synergies, out-of-control margins, and no innovation destroys value.
Both over-investment and under-investment also destroy value. While over-investment leads to increased debt for the company, under-investment keeps funds idle and reduces returns on capital.
An inefficient business model that cannot generate sustainable or recurring revenue indicates fluctuating income, which repels investors/buyers from the company.
As a business owner, you should identify weaknesses that destroy your company’s value and reduce or eliminate them.
Strengths that Build Value
A management team that can run and grows the company independently (i.e., without the owner’s involvement) is a value creator. Investors find companies not dependent on the business owner for day-to-day operations attractive.
Competitive advantage helps companies gain a larger market share and loyal customer base. It also attracts a premium on value from investors/buyers.
Accurate financial records and stringent controls showcase a problem-free company, expedite the due diligence process, and forecast earnings trends, which investors and buyers appreciate.
Increasing cash flows indicate steadily rising revenue. Buyers prefer companies showing upward cash flow trends.
A growth strategy shows buyers that the company has scalability and promises increasing revenues in the future.
A diversified customer base attracts investors as it reduces their risk after the ownership transition.
Robust operating systems show investors that the business does not have the owner or key-person dependency and will continue to run and grow after the ownerâ€™s exit.
When the business owner knows what builds and destroys value in the company, expert value creation advisors can help them develop a value creation strategy to carry out this complex yet necessary process of eliminating the company’s weaknesses and increasing its strengths to close the value gap.
Making a Plan for Value Creation
Knowing the company’s CMV, the value gap, and its strengths and weaknesses creates a solid foundation for your plan for value creation. Therefore, your value creation plan must focus on enhancing those factors that create value and reducing the impact of factors that destroy it.
Making a value-creation plan is a complex process. Those who go it alone have a high probability of getting it wrong. Expert guidance helps you do it right the first time and saves you time and resources.
Professional advisors help you identify the value-creation initiatives essential to closing the value gap and meeting your exit goals. They will prioritize them and focus on the most important ones to accelerate value growth.
Breaking a long-term plan into yearly, quarterly, and even monthly plans by assigning values and timelines to all targets. This helps you stay on track, even in adverse situations.
Start Creating Value!
Once you have a detailed plan of action and deadlines in place, stick to it to create value. However, the plan must be flexible to accommodate changes.
Keep updating your value creation plan by tracking the progress of your value creation initiatives. Learn what is working for you and what is not.
If you cannot reach the desired value in your monthly plan, find out what went wrong. Incorporate what you learn into next month’s plan and the overall value creation plan, and adjust your goals accordingly.
Continue to reassess your value creation initiatives, incorporating lessons learned into the plan, and adjust goals until you have built the desired total value for your company. Get in touchContact with the experts at Quantive today to get started on your value-creation journey.