by Chris Andersen
(click here for Chris Andersen’s Business Valuation webinar recording)
There’s more than one way to value a business. Assay Advisory’s unique approach can help you to increase the value of your life’s work.
Profit growth usually tops the agenda for businesses owners wanting to increase their valuation. But this common approach takes substantial effort, and misses where the real leverage is to increase enterprise value. Businesses can increase the value of their companies through a focus on managing certain risks and leveraging specific strategic assets, in addition to profit growth. Without a risk and asset-based understanding, businesses owners tend to favor a purely profit based valuation. This means many owners lose a vital opportunity to increase the value of their business.
The valuation equation
Most owners are familiar with the business valuation equation: V = P x M, where the valuation (V) of a business equals historical profit (P) times a multiple (M). If profit is $10M and the valuation multiple is 5, then the company is valued at $50M.
The multiple ‘M’ is a measure and judgment of future profit potential. The greater the likelihood of future profits to grow, the higher the multiple, while a lower growth rate or declining profits may reduce the multiple.
Sounds easy in principle, but we have developed a different approach after researching and working with more than 3,000 businesses during the past 20 years.
Understanding the multiple
Each industry has an average multiple. Businesses in the same industry with similar market share, revenue and profitability would typically attract the same multiple – the industry norm or what we call the ‘line’. The traditional finance-based valuation approach starts on the ’line’ and then looks ‘below the line’ for risks that justify lowering the multiple and therefore the value.
In other words, the multiple is discounted because the actual or perceived business risks suggest future profits may be uncertain. We call this a ‘two dimensional’ valuation approach. Instead we adopt a prospective, asset-based approach. While we do look retrospectively at profits, we are equally as interested in how the business will perform in the future.
Use your assets
The third dimension approach reveals what exists ‘above the line’, the aforementioned strategic assets. These are not necessarily present on a typical balance sheet alongside equipment, property, vehicles, etc. These strategic assets are what the business will leverage to generate future profits. More importantly, how will these assets generate future profits for an acquirer or an investor.
How an asset-based process works
When working with clients, we begin by discussing their initiatives to increase valuation before sale. Understandably owners tend to focus on the ‘P’ aspect of V = P x M because they know how to influence profit.
Clients often say, ‘If I increase profits then I’ll get my valuation up.’ While this is true, it misses the other valuation lever – the multiple. While business owners know that profit equals volume multiplied by net margin, they do not have the same level of understanding about the formula that drives the multiple.
During the valuation conversation, we explain how a client’s strategic assets and capabilities have the potential to drive future profit growth while systematically managing and mitigating specific business risks that could impact profitability or the balance sheet. In other words, focus on the business’ ”above the line” features that need to be formalized and demonstrated to an acquirer. In addition, we address ‘below the line’ issues which represent risks to the future well-being of each company. Our aim is to secure these assets that will drive future growth of the business, thus increasing your multiple.
Proactively groom your business for sale
The number of middle market business sales during the 2008-2013 period was much lower than historical averages. However, now that economic conditions are improving, previously unsold businesses from retiring baby boomers are preparing to sell their businesses in ever increasing numbers. The consequence for business owners looking to sell, they will find themselves competing in a very busy market.
If you are looking to sell your business or equity in your business, how will you stand out in this increasingly crowded market? Understanding the assets that sit within your business – and will attract an investor or acquirer – places you in a far better position when selling shares of your company, and increases your valuation multiple.
Less energy required
Instead of struggling to increase profitability alone, increasing the multiple takes less energy. Why? Because you can create strategic assets that will attract the right acquirer or investor. Supporting a business through an asset-based approach to valuation can be summarized in three steps.
1: Value the business today
2: Determine the exit vision and valuation strategy
For example, a business with a current valuation of $10M and an exit vision of $25M has two choices, more than double profitability or increase profits modestly and drive the multiple higher:
3: Design an Equity Strategy Plan (ESP)
Step three is Assay’s specialty. We create a detailed Equity Strategy Plan that will move a business from its current valuation to its targeted exit valuation. Included are a number of stepping stones, which are a combination of strategic initiatives and interim transactions, to achieve the owner’s goals for the business.
Specific focus is given to initiatives that will enhance the business’s valuation multiple. These are identified during our detailed ‘above/below the line’ analysis.
During these three steps, clients become more aware of assets within their business that will attract the appropriate acquirer. Armed with this information, and increased knowledge of acquirer and investor language, clients are more confident and prepared when it is time to sell their business. Now they can offer more than historical profits alone.
Contact Assay to learn how you can give your business ESP.