Value Drivers For Businesses

By:  Brian MacMillan | Managing Director M&A

What enables owners of small- and medium-sized businesses to differentiate themselves from others in their industries? Most privately held businesses are valued based on a multiple of earnings or, in some cases, revenue. However, intangible value drivers can make a huge impact on how much a prospective buyer is willing to pay for a business. Below, I have listed several of these value drivers and their importance to buyers.

BARRIERS TO ENTRY: The more difficult it is for someone to get into your industry, the more valuable your business will be to prospective buyers.

MARKET SHARE AND MARKET POTENTIAL: If your business is in an industry that has limited potential for expansion and your company already has a substantial share of that market, buyers will have less of an interest in acquiring your business. Buyers will pay for your business based on what it has done to date, but the reason they buy is that they feel they can grow the business.

RECURRING REVENUE: Business models in which revenue from customers is maintained each year without the need for additional sales are ideal. Information Technology service providers with a “managed services” model get paid monthly from their customers. Financial Services companies also receive recurring revenue from their customers. Revenues within these companies are fairly predictable, which buyers prefer.

PRODUCT DIFFERENTIATION: Buyers love to see companies which produce or sell a product that is better from others on the market. It is important for businesses that have these products to make sure they maintain their intellectual property so others cannot copy their products.

CUSTOMER DIVERSIFICATION: Companies that rely too heavily on one or two customers may scare off buyers. For example, if your business receives 50% of its revenue from one client and that client leaves, your business will be significantly impacted. Most buyers are not willing to take this risk. By creating a situation where there are numerous customers each making up a small percentage of the company’s revenue, business owners can provide a buyer with confidence that losing one customer will
not “make or break” the company.

SENIOR MANAGEMENT: Many owners of small- and medium-sized businesses have built their companies from scratch. As such, each owner has played a crucial role in growing his business. However, buyers will want to see a company where everything does not flow through the owner. Ideally, the owner has passed on all or most of his responsibilities to the management team that will stay on with a new owner.

SALES & MARKETING: Recurring revenue may be tough to come by in some industries. A great sales and marketing team and strategy can help a business get past this obstacle by constantly and predictably bringing in new business. Buyers will take a close look at the sales process within a company to help determine the viability of the company’s ongoing success and growth.

OPERATIONS: A “clean” organization will pique the interest of buyers much more than a company that does not have any of its systems and processes in order. Agreements with employees, customers, and vendors along with all corporate documents should be up to date and readily available. All human resources activities should be well documented. Businesses should have the proper amount of insurance coverage to protect against any unforeseen liabilities. Buyers will go through extensive due diligence. Having the company’s operations in order can drastically cut down on any negative impact of due diligence (e.g., slowing down the process or potentially causing the seller to back out).

While profitability and revenue can be good benchmarks when trying to determine a business’ value, buyers will take the whole picture into consideration when deciding whether or not to move forward with the acquisition. It is no coincidence that business owners who have implemented the value drivers listed above are the ones with the most profitable businesses.