Business value drivers are those factors that can affect the value of your business and the eventual sale price. Although they could all be important, there are some that are almost always examined by buyers. These are what we call the Ten Fundamental Factors That Affect Business Value, or the key business value drivers.
Key Business Value Drivers
Is your business in a highly competitive market? If the business is selling shoes in a busy shopping mall with many competitors, the multiple will be reduced. However, if the business is selling a patented medical instrument to doctors, the multiple will likely increase.
2. Buyer Market
How many buyers are looking for your type of business? A car wash, for example, requires little effort to run and has steady, long-term cash flow. There are likely to be many interested buyers. But there would likely be much less interest in a roofing business as it requires more effort and knowledge, is very seasonal in nature, and may be very dependent on the economy.
3. Stability of Labour Force
Keeping employees can be a nightmare for certain kinds of businesses. If your business uses a lot of skilled tradespeople, you may have a hard time keeping them from looking elsewhere for better wages. Fast food restaurants can also present labour issues since unskilled employees are not well paid and may move across the street to a competitor for just a slight increase in pay.
If you have a professional business, like an accounting, legal, or engineering firm, you likely have fewer issues. Employees are probably reasonably well paid, and are more concerned with working conditions and the ability of the company to keep them employed.
4. Customer Base
Is your business dependent on a few large customers? If so, there is a risk to the buyer if one of them leaves. On the other hand, if you have many customers, none of whom is responsible for a sizeable amount of sales, there is less risk to the buyer.
5. Owner Involvement
One of our first recommendations to business owners is to go golfing 200 times next year. Of course we don’t mean that literally. What we mean is that your business should not depend on you for a large part of its success. If your customers are used to dealing with you, they’re not dealing with your ‘business.’ If you are a hands-on manager, who replaces you after you leave the business? From a buyer’s perspective, a business that depends on the owner’s involvement presents a very high level of risk.
6. Revenue Streams
Does your revenue come from many products and a variety of different markets, or is it focused on one main area? If it has a large and well-diversified revenue stream, it will be able to withstand a downturn in one area without really suffering financially. This, of course, minimizes the level of risk to a buyer.
7. Age of Business
One of the best ways to predict the future is to look at the past. Does your business have many years of stable cash flow, stable employees, and stable customers? If so, the cash flow multiple will be higher since the buyer’s risk of sustainable cash flow becomes small. Compare this to a business that is only one to two years old and still streamlining basic processes. The buyer will see this as a much riskier situation.
8. Profitability Trend
Ideally, buyers want to see a business that is growing at a moderate and reasonable pace. This suggests good management and a very stable business. A flat-line profit level over a period of years may indicate that the business is stagnating, and the risk to the buyer increases. A business that is losing ground year after year will likely be unattractive to a buyer, unless there is a solid plan to turn things around.
9. Asset or Share Sale
There are only two ways to sell your business: sell the shares, or sell the assets. The most common reason for selling your shares is to take advantage of your lifetime capital gains exemption (in Canada). This will increase the after-tax cash you receive from the sale.
But buyers usually prefer to buy assets because there are less potential legal issues—skeletons in the closet—such as unknown liabilities or potential lawsuits. While steps can be taken to reduce these risks, it makes the deal more complicated and more costly for the buyer. Naturally, buyers see more risk in buying shares than buying assets, and the multiple will reflect this risk. An asset sale can increase the multiple while a share sale will probably reduce the multiple.
10. Availability of Vendor Financing
The multiple can increase if you are willing to provide some financing to the buyer. This shows the buyer that you are not just in this to take the money and run. The confidence you’re showing in the future of the business by using your own funds will increase the buyer’s confidence. It is also an “insurance policy” for the buyer on the transition plan.
Vendor financing will also instill confidence in the buyer’s banker. Additionally, the bank will view the financing as equity, which may give the buyer higher leverage to borrow funds.
Providing some vendor financing can increase the multiple and give you some added negotiation strength.