Business owners are commonly surprised by the valuation of their business, which are often lower than expected. Many business owners don’t realize that they can take control of some of the key factors behind business valuations well before they are ready sell. There are specific external and internal factors of a business that affect buyer perception of value, known as value drivers. It is important for business owners to understand key value drivers and how business value can be improved over time. This is especially important for those counting on the sale of a business to help fund retirement or the next big business venture.
UPDATE: Check out our Value Advisor Library for valuation reference guides.
5 Key Value Drivers
- Accounting Systems & Controls: If business accounting systems and records are weak or don’t accurately show income, valuation goes down. Valuations use tax returns and balance sheets, the stronger the accounting processes in place, the more buyers can trust the numbers.
- Management Team: “Team” is the keyword. A business shouldn’t depend on any one person, including the owner. When an owner is ready to sell, the business must be able to continue to run seamlessly without them. Developing processes and systems to help pass along knowledge and train others within the company will help strengthen the management team.
- Customer Base: Existing customers are very important to potential buyers, who are looking for a diverse customer base. If a customer or a few top customers account for a large percentage of revenues, the customer base is less appealing. Ideally, the top ten customers do not account for more than 50% of revenues and no one customer represents more than 5% of revenues. In addition, establishing reoccurring revenues through contracts demonstrates a strong customer base with revenues a buyer can count on.
- Suppliers: Similar to customers, diversity among suppliers is important. A business creates additional risk when relying on only a few key suppliers. Ideally, the top ten suppliers do not account for more than 50% of revenue and no one supplier accounts for more than 5% of revenue.
- Competition and End Market: Although these factors may be outside of the control of an owner, these external value drivers are just as important to understand. Companies positioned as market leaders, particularly those with proprietary products and strong margins, command better business valuations. Business owners who identify and create proprietary products or systems add lasting company value. In addition, companies taking advantage of end markets that are large, growing rapidly, and have little government involvement are ideal candidates for potential buyers.
These are just a few value drivers that effect business valuations. Generally, strategic buyers, financial buyers and private equity investors pay multiples between 3-6x Adjusted EBITDA when purchasing a business. This presentation includes information on more value drivers and how to quantify them with Adjusted EBITDA multiples: