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Business Valuation Matters: Here’s Why

Posted on October 4, 2022 by

Bryan Powrozek

Bryan Powrozek

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You probably already know business value plays a key role in acquisitions, but did you know it can also boost profits? Learn why business value matters, when to start thinking about it, and ways to monitor and grow the value of your business—even if you aren’t ready to sell yet.  

Defining Business Value 

To maximize the value of your business, it’s important to first have a solid understanding of what business value really means. This informal term is used to describe the estimated health of a business by measuring concrete monetary assets such as employee costs, company assets and overall customer value. Business value should drive every decision ranging from daily operations to strategic long-term planning.  

It’s easy to determine the value of publicly traded companies through market reporting; however, there is no market reference to determine the value of stock in a closely held company. Overcoming these obstacles and successfully determining the value of your privately held company will help you make more informed business planning decisions. 

When to Start Thinking About Business Value 

It’s never too early to start thinking about business value. Prioritizing valuation early on can help you understand the strengths and weaknesses of your business and set targeted goals to improve your overall valuation. By proactively understanding and managing your business even if a transaction isn’t on the horizon, you can be more prepared when an offer does come your way, or you decide you’re ready to sell. Should you already have an offer on the table, it is still worthwhile going through the valuation process to learn if your business is worth more than you initially thought. 

Business Value That Drives Itself 

Many small business owners focus on driving value, but many fail to see how to leverage value as a tool itself to drive further growth. Zeroing in on business value can help you make business decisions based on data, which are easier to consistently and accurately track than decisions based on a more emotional scale.  

While adding value is an obvious goal for most businesses, the harder question is how to do it. Even if you think you’ve created a strong business that is ready to be sold for a profit, how can you effectively convince a prospective buyer of its market value? 

Establishing Business Value 

While important, you will need to consider more than just cash flow and risk. Here are some other levers buyers will want to see.  

  • Diversified Cash Flow—Having a greater diversity of where revenue comes from is more sustainable than relying on a small client base, especially since some customers may not like ownership changes. 
  • Quality of Earnings—The more consistent the accounting records and classifications are, the better. 
  • Quality of Financial Data—Buyers will want to see financial data including financial statements, income statements and balance sheets that go back at least five years. 
  • 3rd Party Accounting—Using outside accounting services lends credibility to the process of evaluating transaction history. By establishing a credible history of trustworthy accounting records, any future forecasting and predictions based on that data is also given credibility. 
  • Employee Handbooks—The policies listed in employee handbooks can impact valuation. For example, consider the policy for vacation time. What happens with unused time? Does it get paid out in cash? If so, it can have a negative impact at closing if this liability was never recorded. 
  • Vendor Dependence—Becoming dependent on just one vendor could negatively affect business value, especially considering the recent supply chain disruptions.  
  • Reliance on Key Management Members—While often unavoidable in small companies, developing employees into leaders can help give buyers confidence that the operation will continue smoothly without the previous owners. 
  • Multiple Offers & Market Competition—Fielding multiple offers can increase the value of a business, but it can be difficult to determine what terms were given, whether cash would be paid upfront, if there is a non-compete or employment agreement involved, and other terms of the deal that could impact the fair market price. Multiple offers should be a starting point for valuations—not the final stage. 
  • Recurring Revenue—Companies can achieve an image of consistency and business longevity by negotiating multi-year contracts with vendors or partners that show more long-term goals. Repeatability with the same client also shows a promising ability to book projects and earn revenue—this confidence drives up valuation. 
  • Budget—Budgeting can help companies understand areas they need to work on and how to work more efficiently. Buyers like to see a history of budgets that have been followed. 

How Owners Monitor Business Value Metrics 

Now that you have a better idea of what buyers are looking for, it’s important to monitor and track these items. Monitoring can be done in a variety of ways. Companies using tools like dashboards to organize real-time data are growing in popularity because they make tracking metrics so much easier than more manual methods. Dashboard technology that may have been cost-prohibitive for companies considering it even just five years ago has decreased significantly in price. 

Differences in Buyer vs. Seller Perspectives on Value 

Value does not always equal price—even with a fair market value of a company. Taking the first offer—especially an unsolicited one—without doing due diligence first can result in leaving money on the table. Regardless of which stage you are at in the transaction process, understanding the value of a business can help build trust to prevent either party—buyer or seller—from being taken advantage of and ensure they are getting the most out of the deal. It’s important to understand how buyers and sellers perceive value. 

Buyer 

The value of a company is impacted by the future—especially for buyers who are always looking forward. Buyers need to look ahead to calculate when they will see a return on their investment. Buyers will often require the seller to provide a forecasted budget looking out 3 to 5 years. Buyers will review this forecast for not only reliability, but also where they might be able to enhance these historical margins. Sellers who can demonstrate a history of forecasting reliability will often receive more favorable terms. 

Seller 

Sellers may have other factors to consider besides money. Long-time owners often view their business as family and want to make sure their workforce will be taken care of by the new ownership. Of course, this does not mean they are uninterested in acquiring the maximum valuation. Tax planning and deal structure play a crucial role in the transaction process as the seller looks to retain the maximum amount of cash. While various deal structures often favor either the buyer or seller, advanced planning can allow the seller to offer the buyer traditional buyer favorable terms minimizing the cash impact to the seller. Sellers who have invested in staff development and leadership training will be viewed more favorably as well. 

Business Value Matters  

As you can see, business value matters throughout the business’ life cycle. It’s important to continuously improve your operations and maximize valuation through informed objectives—whether you are just starting out or looking to grow. Make business valuation a priority today so you can understand what your company is worth and successfully position your business to potential buyers when it’s time to sell. 

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We help business owners like you increase profitability, optimize tax strategies, implement succession planning and gain advantages in mergers and acquisitions. Contact us today to learn how we can help you maximize valuation and set your business up for a successful transaction now or in the future.  

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Bryan Powrozek

Senior Manager

As the leader of the firm's industrial automation group and host of The Sound of Automation podcast, Bryan helps owners free up cash flow and scale their businesses.

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