Knowing the eight drivers that determine a business’s value is the first step to knowing what your company is worth
Different business owners are, well, different. They practice different leadership styles, sell different products, and employ different strategies. They all have one thing in common, however: they want to increase the value of their businesses.
And whether you plan on exiting your business in the near future or staying on for a while longer, increasing its value through concerted, concrete steps must be a priority.
What is your business worth?
It’s a straightforward question, but one that puzzles many business owners. After all, every company is unique, which often makes the art of valuing a business something of a “subjective science.” Certain factors are based on the business itself—such as the net value of its assets, for example—while others are the result of outside circumstances, like the sales of comparable businesses within the same industry.
In most cases, businesses are valued as net profit times multiple. The multiple is applied to a specific financial metric of a company to calculate its valuation. The most common financial metrics that multiples are applied to are:
- EBITDA, or earnings before interest, tax, depreciation, and amortization
- EBIT, or earnings before interest and taxes
- Net earnings, or earnings minus the cost of goods sold, taxes, and expenses during a period of time
- Revenue, or the earnings a company receives during a period of time
Put simply, the multiple is as a measurement of risk—the higher the multiple, the less risky the investment for a buyer. To increase the value of their business, owners must do one of two things: increase profit or increase the multiple.
The VBS: an introduction
Business valuation professionals use a variety of methods to help owners determine what their business is worth and increase its value. One of the most comprehensive and highly regarded methods is The Value Builder System or The VBS. The brainchild of John Warrillow, author of the best-selling book of Built to Sell: Creating a Business That Can Thrive Without You, The VBS is a statistically proven methodology for increasing the value of a company through increasing the multiple.
The VBS differentiates itself from other methodologies based on 8 factors, or “drivers:”
This is the most straightforward driver, but it’s also one of the most difficult to deliver. It’s made up of your top-line revenue and your bottom-line profit, but there are other elements to consider as well. Have you invested in an audit? If a buyer were to scrutinize your numbers, do they add up?
Many business owners view their business based on its past successes, but a buyer will typically focus on its potential. What does the future hold? Can this business operate in a different market if needed? Can you cross-sell additional products or services to existing customers? These are all questions that determine a business’s growth potential.
A successful business is an independent one. It doesn’t rely on a particular customer, employee, or supplier in order to operate efficiently or effectively. Some questions to consider: Do you have diversification among your customers and suppliers? Are you overly reliant on a single employee? If not, your business is a risky investment for potential buyers.
Valuation Teeter Totter
The more cash your company needs to operate, the less likely a buyer is willing to pay for it. In other words, your business needs to be generating cash. Can you collect receivables faster? Can you extend your payables? Doing so will help you improve your Value Builder Score.
Have you considered how your business will continue once you leave? Even if you don’t plan on exiting any time soon, this is an important factor in your business’s value. There are six main ways to create recurring revenue. In order from least valuable to most valuable, they are consumables, sunk money consumables, subscriptions, sunk money subscriptions, auto-renewal subscriptions, and contract revenue.
Can you move up this ladder? Can you channel your sunk money subscriptions into auto-renewal subscriptions, for example? If so, you can increase the stability of your recurring revenue.
When investing in a company, renowned investor Warren Buffet looks for the durability of a company’s competitive advantage or its “moat.” The wider the moat, the more leverage a company has. This leverage allows a company to control its pricing, which in turn creates more margin, better sales, marketing, and so on. Some questions businesses should consider: Does my marketing make my business different from my competition? And do my customers care? Is this a unique advantage likely to stay unique?
Happy customers are an obvious driver of a company’s value and success, but it can be difficult to gauge customer satisfaction in quantifiable terms.
Enter the Net Promoter Score (NPS). Your company’s NPS answers the question, How likely will my customers recommend me to their friends? The more data you have on this particular subject, the more you and your potential buyers will know that your customers are satisfied.
Hub & Spoke
Are you the “hub” of your business? If so, the likelihood of your business falling apart once you exit is high. In order for your company to succeed long after you leave, your customers, employees, and suppliers can’t be solely dependent on your contributions. One way to begin solving this problem is by documenting your processes so your employees will know how to operate when you’re not present.
Getting started with The VBS
These drivers come together to determine a business’s Value Builder Score. On average, companies with a Value Builder Score of 80 or above (The highest score is 100) receive offers that are 71 percent higher than the average business.
Now that you know which factors drive a healthy, successful, and high-value business, you can increase the value of your own company. The first step is to find out your business’s Value Builder Score, and an expert business advisor can help you determine this number—and figure out ways to improve it.
Provident CPA & Business Advisors serves successful professionals, entrepreneurs, and investors who want to get more out of their business and work less, so they can make a positive impact on their lives and communities. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning and business strategy, and to find out how we can help your business exceed your expectations.