Business Valuations – Why You Should Have One

A closer look at why you should consider having your business valued.

Dated: 4 November 2019 Author: Roy Farmer, Head of Corporate Finance

There are many reasons why having your business valued makes sense.  A trigger for a business owner to have a valuation is often when a sale process is being considered or where an unsolicited approach has been received, or perhaps when one shareholder needs to exit.  However, rather than wait for such an event to trigger a business valuation, we actively encourage business owners to carry out more regular business valuation exercises. 

The valuation exercise and its findings can often act as a catalyst to enhance the value of the business by enabling you to make better-informed decisions and clearly identifying its strengths and weaknesses so that can plans can be put in place to build on or address these.

Whilst there are several ways to value a business, of which a multiple of profits is one which is commonly used, a business valuation is not simply about taking a snapshot of the most recent reported profits and applying an appropriate multiple.  The value of a business is driven by its sustainability over time, the perceived risks that exist within the business as well as its growth prospects, all of which cannot be discerned simply through a basic review of the profitability currently being achieved.

The process of a business valuation can lead to a more forensic understanding of your business.  At its most basic it can highlight areas where revenues and margins can be improved and overheads reduced, resulting in higher profits and better cash flow and improve the valuation.  For example, we see many businesses that are incurring costs not core to the business activities or carrying cost inefficiencies say around poor workforce productivity which under alternate ownership would not take place, both of which have an impact on profit.  Sometimes these costs can be hard to specifically identify or to demonstrate are not necessary to the running of the business under different ownership, which can then have a detrimental impact on the valuation achieved.

A business valuation can also identify where working capital management can be improved, thereby reducing the cash lock-up.  This is an area which can often have a material impact on valuation, but which is often overlooked until a sale is being considered, at which point it can often be too late to make the necessary changes to have a positive impact on the working capital and cash position.  A business valuation exercise can also increase the rigour with which capital expenditure decisions are made, by properly considering the return on investment and payback periods the investment achieves and help determine how value enhancing these decisions will be.

Where a business has the potential to achieve significant growth in revenue and profitability but requires investment to achieve this, a business valuation can help determine whether the profit growth and value enhancement outweighs the risk being taken and the cost of capital required (debt or equity) to achieve this growth.

For small and medium-sized businesses, something which is regarded as a value driver by the business owner can represent risk to a potential investor or even the business itself.  As an example, a company may have deep customer relationships, which have taken years to develop.  However, if a significant percentage of a company's revenue is derived from one client, or if that relationship exists purely with the business owner, then from a valuation point of view it can represent a significant risk.  Typically, the more diverse a company's client base is, the more value it attracts, and similarly diversity across industries can often help to protect a business and therefore enhance its value further.  By identifying these potential areas of risk and developing a plan to mitigate against these risks, the valuation of a business can be improved.

Other areas of weakness could be around retention of key employees, production inefficiencies, poor customer retention, all of which have a negative impact on profitability.  These areas may not be capable of being fully resolved but with some planning actions could undoubtedly be taken to start to address these weaknesses.

Obtaining a business valuation does not have to be an expensive exercise but the financial returns can be enormous, through better understanding and concentration of effort. I would encourage business owners not to leave it, until it is too late.

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