If you ask most business owners what drives the value of the business, most will tell you first and foremost is financial performance. Financial performance is important but is only one of several variables that affect the value of your business. When it comes time to sell your business down the road, there is much more to it than just having steady revenue and a good profit margin.
Most businesses worry about the value of their business when they are ready to sell their business. Unfortunately, at that point, it is way too late to make any changes. Instead, if you focus on the areas that drive your business value early on in your business, you have a better chance of receiving the value and earnings multiples you want for your business down the road.
Other factors will affect your business value and the multiplier of what you will eventually receive for your business that many business owners do not consider. To change any of these, it will take time, so you must look at them early on within your business, so you are running your business so that if you had to sell it tomorrow, you would receive the value you deserve.
Dependence on the Business Owner
We always ask business owners how involved they are in the everyday running of the business, including sales with clients. In some cases, the business owner will smile and tell us how they know their clients by name and ask for them. In addition, they will tell us how the clients will come to them anytime they have a problem. Then there are business owners who tell you how they really can't afford to take a vacation, as the business would not continue to run.
Unfortunately, both of these are a problem because if the business revolves around the business owner, this dramatically reduces your business's value. The company is not worth anything without you in it. Owner over-involvement also decreases the chances of someone down the road buying the business. In most cases where the business owner is too ingrained in the business, there are no documented processes and procedures, so the business cannot manage without them. In most cases, everything usually resides in the business owner's head, so it is not a business that could easily transition. This affects the value and is why most service-driven businesses do not obtain the same value and have a lower earnings multiplier versus product-driven businesses.
Dependence on One or Two Key Customers
It is wonderful to have large customers, but it is a problem when your business relies on one or two key customers to make up more than 30% of your revenue. Nothing is a sure thing, and if something happens, one of those clients leaving could put you out of business if you cannot replace them quickly. Sometimes with a large corporation, they could move their business elsewhere without giving you much notice, or it could be as simple as the contact that brought you in, leaving the company.
It is important to make sure that if you find yourself in this situation, you look at reducing your dependence on them. Options are selling to additional customers, looking at new geographies, or even adding other products and services that you can sell as add-ons to other customers or new customers. These take time and may involve hiring sales reps or even looking for other products & services to develop or resell. Recovery from this is not something you can change overnight, so it is important not to wait until you want to sell your business, as this will greatly impact the value you receive as this is a very high risk to the buyer. If the buyer sees a high dependence on those clients, it will lower your value as it increases risk.
Dependence in One Supplier
When we all start out, we try to find that one supplier can fulfill as much as possible for the best price without realizing how risky this is. There is nothing wrong with using that supplier, but you will want one or two backups that you might occasionally buy from if there is an issue. We had a client where their main supplier went out of business, and they were scrambling to find another supplier of their raw materials, as they had not researched this prior. Another client had their main supplier who in the past had been lenient on payment, stop supplying products until their outstanding balance was paid off, and became a catch 22. They couldn't make products to sell without the materials the supplier provided, and they needed the materials to earn money to pay off the bill.
When you look to sell your business, this is yet another element that the buyer will look at to determine risk. The increased risk lowers the value of your business.
Dependence on One or Two Employees
There is a similar situation when your business is reliant on one or two key employees. If today you only have one sales rep, and they make all of the sales for your business and others in the business are not involved with customers, this can be a potential issue. What would happen if something happened to this individual or they left tomorrow - ask yourself - would your business still survive? Do you have your customer list and contact information, or did that walk out the door with the sales rep? Reliance on any one person can have an impact on the value of your business as well. A question you need to ask yourself for each of your employees is if they quit tomorrow, would your business be impacted.
Summary
Dependence on the owner, customers, suppliers and employees are other factors that will impact the value of your business outside financial performance. Still, as you can see by the examples, none of these items are things that you can change in your business overnight. It doesn't even really matter if you never plan to sell your business, as your business is exposed to risk if any of the instances occur and should be part of your strategic plan to address.
We work with clients to increase their overall business performance and decrease risk, which includes looking at all areas that will affect the value of your business. We also perform business valuations for those that are looking to sell or buy a business. We offer a FREE business performance assessment which includes a 30-minute session with one of our partners.