Here Is What Makes for a Valuable Company?

Ah, the Complexity of it All! Valuing a company is extraordinarily complex. And there is no single factor or measure that will give you the answer, without at least heavy reference to other factors and measures. My first recommendation is to read How To SELL Your Business, by me and Carl Stratton, which contains a number of chapters on valuation.

But here is a start, understanding all factors combine in a “stew” that the market then analyzes and produces potential buyers willing to pay a certain amount for your business. Generally, the more attractive your company, the more buyers will be interested in buying it, and the higher the price it will attract.

Once the sale is done, that is your value. And note that a business appraiser can only make an estimate of value, and that estimate may or may not be near to what an informed, willing buyer will pay a willing seller with no undue pressure, which is the generally accepted definition of fair market value. In other words, it is the sale transaction that proves out the value; an appraised value is simply an opinion of value.

The Hallmarks of a Business Desirable to Most Investors

·      Strong proven growth – the more growth, the higher the value. A minimum of 15% to 20% annual growth is often sought by buyers, but slower growth may attract buyers if they think they can grow the business at a greater pace than you have.

·      Solid growth prospects – while it’s nice to have past growth – proof in the pudding – the market will need to be convinced that growth will occur in the future.

·      Good profit margins – every industry has its standard margins - both gross and net – and you’ll want to be at or above those industry standards or have a good explanation for why you are under. Slim margins increase the overall risk of the business, and robust margins decrease the risk.

·      No Undue Customer Concentration – sales should not be concentrated among one or a small number of customers. If they are, buyers will not value your company highly, given they will be concerned about the loss of that one or those small number of key customers. Diversify your revenue base.

·      Proprietary value (something that makes it not a commodity) – your mission will be to characterize whatever gives you a competitive advantage as proprietary value.

·      A solid employee and management base and structure – few people want to buy a company lacking these.

·      Solid processes and procedures – same with these.

·      A high employee retention rate – it’s worth a lot more if the cast of people behind the company doesn’t have to be repopulated constantly.

·      Good reporting and accountability mechanisms – without these, credibility, and hence value, is diminished.

·      A solid record as good member of the community – no buyer wants to have to fight against a poor community record and create a new, more positive one.

·      A low risk profile – higher risk means the buyer will need a higher return, which means they will pay less money to earn that return.

·      Professional representation in all dimensions (e.g., offering materials, legal and accounting representation) – because they bolster credibility and, with it, value.

The Tradeoffs Among Valuation Factors. Let’s address probably the most important determinant of value…growth. Can you sell your business if it is not growing? Quite possibly, but the valuation will be much lower than what would be paid for a growing company. For example, a company with $20 million in sales and $3 million in net profit, which have been flat for three years, might be worth three times net profit, where a company that is growing at 20% per year might be worth six times net profit. (Note: we address this in other posts, but the proxy for net profit used in valuing most businesses is “EBITDA,” or earnings before interest, taxes, depreciation, and amortization.)

What about the other factors? Again, the valuation equation is a complex stew. Having the “hallmarks” above will increase value and not having them will decrease it. Virtually every valuation is unique.

GROW and SELL Advisors, wholly-owned by Traversi & Co., LLC, is a premier sell-side M&A advisory firm – a boutique investment bank – serving the lower middle market.  Visit us here.

For a short video clip on this topic, click here.