Understanding what your company is worth is a core consideration for many business owners as its value will have a considerable effect on your own future plans.

As a business owner, it may be your objective to build and grow a business which you will look at selling to a third-party buyer or pass on to family members. Therefore, building and increasing business value is an important consideration as you run your business and when you’re making major business decisions.

Rome wasn’t built in a day and businesses can’t ordinarily increase value overnight. You need a long-term strategy to build value in your business.

Focusing on key areas that build intrinsic value will not only improve your business day to day but will also dramatically affect how your business is perceived by future buyers and increase its value in the long-term.

In this blog we will cover the key areas that drive and increase business value.

Increasing the valuation multiple

Many company valuation methods use a multiple of earnings approach to calculate the value of a business. A higher multiple will be achieved when a buyer attaches less risk to the ability of the business to maintain its earnings into the future.

The multiple used therefore has a significant impact on the value achieved for your business – but there is no scientific formula or calculation used to determine precisely the ‘correct’ multiple.

You’ll negotiate this with the buyer. External factors will influence the multiple – such as the type of industry you operate in – but many internal factors, within your control, will also be instrumental in determining the multiple.

All the value drivers in this blog will affect the value multiple that your business sale achieves.

The buyer’s perspective

Ultimately, your business is only worth what prospective buyers are willing to pay for it.

Identifying any issues that will affect business valuation from a potential buyer’s perspective and taking corrective action or having plans to correct those issues will put you in a better position with a potential purchaser. This is especially important if you already know the likely identity of a buyer, or if your pool of potential buyers is small.

Buyers are likely to already be acquisitive, so identifying their investment strategy including their valuation technique can sometimes be possible (using trade news etc). Aligning your business accordingly can increase its value.

Factors that drive business value

1. Financials

The main financials that will increase business value are:

Cash flow – Buyers will calculate the value of your business by estimating future cash flow and predictable cash flow, assessing the risk associated with generating that cash flow. If your business has a track record of sustainable or increasing cash, it reduces the risk a buyer could attach to your business.

Revenue – Buyers are likely to look at the previous three years’ financial data. Showing steady but consistent revenue growth is better for business value than sharp spikes in revenues. Inconsistent spikes in revenue make it harder to forecast future revenue and could therefore decrease value. A recurring revenue business model is the key to achieving a steady stream of revenue and increasing value.

Capital structure – Capital structure is the combination of debt and equity that you use to fund operations and growth. Reducing debt or refinancing to a cheaper source of debt will help increase value. The balance of net debt (debt less cash and cash equivalents) at the time of sale will usually be subtracted from the purchase price.

Audited financials – Having clean financials and a number of years of audited accounts can also add value to your business. Audits ensure that the financial statements give a true and fair view, and adds credibility. This can give potential buyers peace of mind. Often an audit process can highlight value, by recommending areas of improvement in a business such as ways to improve management information, compliance, and minimise risk. All these areas, if acted upon, can add business value.

2. Capital expenditure (CapEx)

Potential buyers will look at how your company’s CapEx requirements for both maintenance and growth expenditure will impact cash flow. The effect of CapEx on your company’s value will depend on the category of CapEx being spent.

Continuing to invest is important to the value of your business. A mistake that is often made is to neglect CapEx investment and maintenance in the run up to a sale to build cash reserves and improve reported profits – but astute buyers will be wise to this. Ultimately this type of short-term thinking will be harmful to the business’ future prospects and this will flow through to the sale price achieved.

3. Quality profit vs quantity profits

Many owners focus on building a profitable business, it’s important to not only focus on the quantity and increasing profits, but also the quality of your profits is important. Buyers will look at the potential for repetition of profits.

Having a strategy to increase the profit multiple of your business longer term may have a negative impact on short term profit, however, if you improve the quality of the profits in your business, it will undoubtedly increase the price that a buyer is willing to pay for your business in the future.

4. Over dependency

If you are looking to increase business value, then you need to ensure that your business is not over dependent on any key person, customer or supplier. The less dependent your business is, the more value it will have to a potential buyer. Having a management team in place that can run the business in your absence is key to avoiding over dependency on you as the business owner.

There are four key components of dependency:

People – Is the business dependent on you, the business owner, or one or two key shareholders or team members and their knowledge?

Customers – Is your customer base diverse? Is a significant portion of your revenue dependent on a single client or few major customers?

Suppliers – Does your business have supply chain risk from over dependency on a few key suppliers?

Products/Services – Does your business model rely on one core product? Could you diversify and spread risk?

5. Intellectual property

Identifying intellectual property and protecting it will increase business value. Having things like patents, copyrights, brand names and trademarks will not only minimise risk but can deter competition and increase your market position. These areas will all add value for a potential buyer.

6. Business structure

When thinking of the future value of your business, it is essential to review all the elements of your corporate structure. An inefficient corporate structure, such as one containing redundant corporate entities, or a complex structure will reduce value as well as protracting any future sales process.

Consider the need to restructure to add value, perhaps to simplify and make it easier for a purchaser to buy precisely what they want, or to secure tax efficiencies, mitigate risk, streamline operations and make savings/synergies.

7. People

People are the heart of most businesses and creating a strong second-tier management team is important to increase business value. A strong management team will also reduce the dependency of the business on you as an owner. Relying on a single key employee as your second in command is often seen as risky to prospective buyers.

Building a management team, long before you aim to sell is imperative and showing that your business can survive and thrive without you is something potential buyers will want to see.

Employee engagement and employee satisfaction can also be a key driver in business value. Statistics show that a highly engaged workforce can increase efficiency, sales and customer satisfaction. Companies with great employee experience will often outperform competitors on innovation and profitability, so it can be a key differentiator if your potential buyers are looking to choose between the purchase of your company or a competitor company.

8. Operations

Buyers look for companies that have effective operations as this helps a business gain and maintain a competitive advantage. Providing a buyer with a proven operations strategy assures them the business is well positioned to sustain and increase profits and market value.

Business owners need to demonstrate that the business has the right systems and processes in place to function effectively. Having documented procedures will show a buyer that the company can continue to operate smoothly post sale.

Strong controls will help to reduce the number of warranties and indemnities needed as part of the business sale, because the buyer will be more confident that risk has been minimised.

9. Contracts and legals

Having formal agreements and contracts with your customers, suppliers and employees is key to business value. Contractually securing relationships, whether it’s to minimise risk in the supply chain, or customer contracts to secure future revenue, adds stability and value.

10. Marketing, brand and competitiveness

Companies spend thousands of pounds to create brand awareness of their products or services and to increase their brand value. Brand value can be calculated based on both current and future sales, as well as the potential for future growth. Creating a strong, well-recognised and highly regarded brand will attract new customers and increase your market value.

Having a clear competitive advantage over the rest of the market may increase value in the short term, but if it’s likely your competitors will soon catch up then it won’t impact long term value.

Summary

Creating value in your business should be an ongoing process from day one of setting up your company.

Getting your financials in order, working on other value drivers and elements such as restructuring can take time, so you need to plan and work throughout your business lifecycle on improving the value of your business.

At Barnes Roffe we can advise you on getting your financials in order, restructuring and other value drivers in your business. We can also help with business valuations, and provide support with business acquisitions and sales.

How Barnes Roffe can help

Barnes Roffe support business owners from all sectors throughout their exit planning and sale process including: 

• Succession planning advice and support
• Creating your exit strategy
• Business sale
• Tax planning
• Identifying and approaching potential buyers
• Management buyout support
• Employee Ownership Trusts
• Trusts and IHT planning

If you would like more help and advice with planning your exit strategy, then contact us today.