Our clients use business valuations for many reasons. Litigation? Check. Underwriting? Yep. Shareholder Agreements? Absolutely. Although, one of the ways we love to see our clients engage our services (and quite frankly, we don’t see this reason enough) is for gap analysis.
What Is Gap Analysis
It sounds fancy, right? As a concept, gap analysis is pretty straightforward. From Investopedia, Gap Analysis is:
A gap analysis is the process companies use to compare their current performance with their desired, expected performance. This analysis is used to determine whether a company is meeting expectations and using its resources effectively.
Gap analysis consists of:
- Listing of distinguishing factors (such as attributes, competencies, performance levels) of the present situation (“what is”).
- Listing factors needed to achieve future objectives (“what should be”).
- Highlighting the gaps that exist and need to be filled.
Gap analysis forces a company to reflect on who it is and ask who they want to be in the future.
Using a Business Valuation for Gap Analysis
You can think of valuation in terms of a bell curve, as with many things. For any given company, there is a range of potential valuations. Specific scenarios will be present on the lower end of the curve. A perfectly average company presents in the middle. And, of course, great companies present at the top end of the value range.
By engaging a firm to perform a business valuation, you are essentially laying the groundwork for establishing the “zero case,” or Vo in our illustration. The question, then, is how do you move the valuation to reach a higher valuation? Your valuation analyst can work with you to understand:
- What factors or risks are present in the company holding value down?
- What actions might the company take to improve value?
- Are there risk mitigation steps that the company might take to improve value?
- What will the impact on improved earnings have on value?
Improved Earnings and Reduced Risk: The Double Whammy
One final note. Working through a gap analysis (which ultimately is often a several-year process) often impacts management on risk areas to address and profit potential to improve on. When you undertake steps to improve profit AND mitigate risk, you are essentially improving your valuation “multiple” AND multiplier. Your return is more than 1:1.
Your initial valuation indicated a V0 of $5m. Your valuation multiple (we hate these, but they work for illustration) is 4.0x. So $1.25m earnings times 4.0x multiple = $5m valuation. After working through your gap analysis and implementing a plan to improve, you’ve mitigated most of your serious risk factors. Earnings have improved to $2.0m. Your valuation multiple has improved to 5.0x. New valuation? $10m.
- Gap analysis is the act of comparing the current status to a projected status of a company. This is typically done with a value gap.
- One can use a business valuation to ensure they are comparing correct numbers. Business owners can also use an analyst to help them answer helpful questions on the next steps.