What Drives The Value Of Your Business?

Dr Craig West is the founder of Capitaliz and has been working with business owners on succession and exit strategies for over 20 years.

Our homes are pretty easy to value. Most owners know the value of their home and comparative data is typically readily available. However, businesses can be hard to value and very difficult to compare. They are complicated assets with multiple factors influencing the valuation, including financial performance, economic trends, industry factors and company-specific risks. In most cases, identifying the key valuation drivers—either positive or negative—is difficult.

Any succession or exit planning process should start with a valuation—an independent business value assessment. In my experience, business owners rarely get the valuation right. They either think the business is worth far more than is realistic or can completely undervalue the asset. If this is the case, it is almost impossible to correctly or accurately design and implement a strategy for succession or exit.

If you’re a business owner, you need to know how important it is to understand your business’s key value drivers. Luckily, there are reports specifically designed to solve this problem—business insights reports that can help you do just that. Using this report, you can gain valuable insights into your business’s performance and identify improvement areas, reduce risk and increase the value of your business.

A business insights report will provide you with a wealth of information, including data on your revenue, expenses, profits, cash flow, breakeven and sustainable growth rates, and a detailed examination of business risks. A breakdown of the non-financial metrics will highlight both risk areas (which will reduce the valuation) and opportunities for improvement (which will increase the valuation). Business owners can access a business insights report with this kind of information by working with an exit planning advisor, an accountant or with a wealthtech platform that provides it.

The information includes industry-based benchmarking, and one of the best ways to use this report is to focus on the metrics that matter most to your business. For example, if you’re a retail business, focus on metrics such as sales per square foot or inventory turnover. If you’re a service-based business, focus on metrics such as customer retention rates or average revenue per client.

Once you’ve identified the key metrics, you can use the report to identify trends over time. Look for patterns in your data, such as seasonal fluctuations or changes in customer behaviour. By understanding these trends, you can make more informed decisions about allocating resources and improving your business’s performance.

In addition to identifying trends, a good business insights report will help benchmark your performance against industry standards. Look for benchmarks in revenue growth or profit margins and compare your performance to other businesses in your industry. This can help you identify areas where you may fall behind and make changes to catch up.

Two important concepts that the business insights report introduces are value potential and dynamic revaluation:

Value Potential

This model allows owners to identify not just the current value of the business but its value potential. In other words, if your business today is worth $5.3 million based on the typical valuation, the value potential model will tell you not only that its current value is $5.3 million, but that it could be—or should be—worth $7 million and, importantly, outline the critical steps you can take to increase it to that value. Every business has a value potential factor, and some are quite significant. Owners should establish the value of the business today and its value potential to determine the increase in asset value.

For example, my company conducted an analysis that uncovered a large gap of small and medium-sized businesses. We found that these businesses are undervalued by $3.7 trillion in aggregate or approximately $1.3 million per mid-market business. The primary reason for the value gap is the absence or poor structuring of succession plans. Starting this process early will only help bring your current valuation closer to your value potential.

Dynamic Revaluation

Dynamic revaluation allows owners and their advisors to continually monitor changes in the company’s value, which will typically occur as a result of changes in one of four key factors: economic factors like interest rates, inflation and foreign exchange rates; industry factors like technological disruption or macro-economic trends, which affect a particular industry; financial performance, which is ultimately the company’s profitability; and risk factors which are often determined by non-financial metrics.

Non-Financial Metrics

The assessment of the non-financial metrics is key. These metrics are often overlooked in business valuation, but they can have a impact on the value of a business. By identifying and improving key risk factors, you may reduce risk and increase the valuation of the business. Issues like owner dependence, customer concentration, corporate or financial governance and employee turnover. Identifying and improving these areas will reduce risk and increase valuation. Typically, in any asset class, the higher the risk, the lower the valuation. This is especially true in smaller and medium-sized businesses.

Overall, getting a firm grasp on the core areas covered in a business insights report can be a powerful tool for any business owner looking to understand the critical drivers of value in their business. Using this report to analyze your performance and identify areas for improvement has the potential to make more informed decisions and drive long-term success as you launch into a business succession or exit plan.

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