How to Increase Business Value
The goal of most business owners and entrepreneurs is to build a business which they can eventually sell. Therefore, creating business value throughout the lifecycle of your company is a crucial consideration when making strategic business decisions.
Consistent revenue growth and profitability are not the only drivers of a healthy business valuation. Owners can often overlook many of the levers that drive business value until late in their business lifecycle, and this then leads to unrealistic expectations about their company’s value.
In this blog, I’ll examine some of the key areas that increase the value of your business.
How are businesses valued?
Understanding the valuation multiple
There are several methods for calculating a business’s overall value. However, many valuation methods use a multiple of earnings approach. The lower the risk in your business, the better equipped it is to maintain earnings and profits in the future, which will ensure a strong valuation is achievable.
There is no set formula or calculation used to determine the correct multiple. The valuation multiple is usually negotiated with the buyer. However, every business owner should be aware of the internal and external factors that influence the multiple.
External factors that affect value include the sector in which you operate, the sector’s future, and economic factors. Internal factors that you can control will not only impact the ultimate value but also the future growth of your business.
How can a business increase value?
There are several strategies that business owners need to understand and adopt to increase value.
Key Value Drivers
Knowing what drives value in your business is the key to improving long-term value. Business value is based not only on its past track record but also on the company’s future expectations and projections. This is why it is critically important for a business owner to understand the factors that drive value – we refer to these as value drivers.
There can be hundreds of factors that drive value, and some of these value drivers may be specific to your business or your industry. However, we cover some of the key value drivers for the majority of companies below.
1. Building sustainable cash flow
During valuation, buyers attempt to estimate future cash flows and assess the associated risks to that cash flow. Creating sustainable cash flows will reduce the risk that the buyer attaches to your business.
2. Maintaining consistent revenue growth
It’s usual for a buyer to want to assess the previous three years’ financial data. Showing steady but consistent growth in revenue, rather than sharp spikes, will positively impact business valuation. Recurring revenue streams will be key to achieving a higher valuation.
3. Enhancing profit quality and consistency
A key to business valuation is not only to increase profitability but also to improve the quality and consistency of profitability. Owners tend to focus on total profitability and gross margin but often overlook the quality and consistency of those profits.
Buyers will not only consider the ability to generate more profit in the future, but also the potential for repeat profits. It’s worth noting that focusing on the long-term profit multiple of your business may harm short-term profits. But improving the quality of profits in the long term will undoubtedly increase the price that a buyer is willing to pay for your business in the future.
4. Managing capital expenditure (CapEx) strategically
Business owners often stop or neglect capital expenditures (CapEx) investment in the run-up to selling their business to build cash reserves and improve reported profits. However, experienced buyers will see through this strategy. This type of short-term thinking and lack of investment could harm the business’s prospects, ultimately impacting the sale price achieved.
5. Optimising capital structure
Capital structure refers to the combination of debt and equity used to fund operations and growth. A higher valuation could be achieved by reducing debt or refinancing to a cheaper source of debt. At the time of sale, the balance of net debt (debt minus cash and cash equivalents) will typically be deducted from the final purchase price.
6. Improving financial records and controls
Maintaining well-organised financial records and implementing robust financial controls can significantly add value to your business. Audited accounts can give potential buyers peace of mind by ensuring that the financial statements provide an accurate and fair view of the company.
An audit can also identify areas in need of improvement, including management information, compliance, and minimising risk. If progress is then made in these areas, a higher valuation may be achieved.
Building a strong management team
A strong management team is particularly important for increasing business value. Building a management team long before you want to sell is key to maximising business value.
You need to prove to potential buyers that your business can survive and thrive without you. An over-dependency on you running the business may hinder your future growth potential and ultimately the price you achieve on sale.
Enhancing operational efficiency
Having robust systems and processes in place can improve operational efficiency and company valuation.
Providing a buyer with a comprehensive and well-thought-out operations strategy assures them that the business is well-positioned to sustain and increase profits and value.
Documented procedures and strong controls will prove to a buyer that the company can continue to operate smoothly post-sale. Strong controls will reduce the number of warranties and indemnities requested as part of the business sale, because risk will be minimised for the buyer.
Reducing dependency risks
The structure of your business and its risk management approach are crucial factors in determining a business’s value. If your company is overly dependent on specific areas, then the value will decrease.
There are four main areas of over-dependency to consider:
- You, the business owner – Could the business run without you?
- Customer base – Do you have one or two main customers that could threaten the future of the business if they were to stop buying from you?
- Supply chains – Do you have over-dependency on one or two suppliers? What is the potential for disruptions in your supply chain, for example, to the flow of goods, services or information, and how can you minimise this risk?
- Product lines/service ranges – Are you overly reliant on one or two product lines?
Encouraging innovation and embracing technology
Innovation and development of high-quality products can improve value. Investing in technology can also add value. Technology can enhance processes, controls, and efficiencies within a business.
However, innovation and technology are not just the domain of the R&D department; innovation can be demonstrated in other areas of the business. Innovation can be highlighted in culture, processes, agility, and the overall management team.
Strengthening marketing, positioning & competitiveness
Companies with a unique market position, a good market share, and a strong, well-recognised, and respected brand will command a higher value.
Securing Intellectual property
Identifying and protecting your intellectual property will increase business value. Ensuring you have patents, copyrights, brand names and trademarks will minimise risk and improve your overall market position.
Establishing robust contracts and legal agreements
Contractually securing relationships with suppliers, customers and employees will minimise risk in the business and will add stability and value.
Taking a buyer’s perspective
Understanding that your business is only worth what someone is willing to pay for it is essential in the end. You need to be able to view the company from a buyer’s perspective. This will likely help identify issues in advance and enable you to develop plans to navigate challenges before the sale.
Expert accountancy advice to help maximise business value
For help and advice on improving your company valuation, building strong financials, minimising risk and selling your business, contact Edwards Accountants today. Our experienced advisors can help you build value and minimise risk at every stage of your business journey.