Building Blocks of Business Valuation

Building Blocks and Best Practices for Driving Business Value

Business valuation is not an original or uncommon topic. It is, however, one that business owners and leaders should be far more focused on and reminded of often. That’s because many who start a business don’t always fully consider business value when developing their original strategy or get pulled into weeds that cause them to drift or lose focus along the way. Then, when the time to transition or sell their business does come, they find that roads of convenience were followed more so than paths that would have put them in a better position.

It’s important to recognize that maximizing the value of a business is not typically a quick-fix scenario. It also entails far more than just financials. Anyone with thoughts of selling their business within five years would be wise to get to work now. Below, we explore several factors that contribute to business value and what can be done to move the needle in the desired direction. A good place to start is benchmarking yourself against your competition.

Customer Base Diversification

A deep and diversified customer base lowers the risk that a single or small group of potential customer defections have a severe impact on the business. This is essentially the “don’t put all your eggs in one basket” proverb at work. Take a Pareto approach and determine whether a small group of customers is responsible for generating a lion’s share of the revenue. If that assessment of the customer portfolio shows that the base is too heavily weighted, one step would be to examine sales strategy and whether broadening the customer base across new markets or industries or via new offerings is a viable play.

Access to Capital

If one doesn’t have their own well of capital to tap into, having solid banking or equity relationships is a must. Without that access to capital, businesses can’t take advantage of opportunities in front of them or effectively weather storms when disruptions like those we’ve seen over the past several years raise their ugly head. In short, insufficient access to capital limits growth and raises risk.

Economies of Scale

Businesses that customize a high proportion of their product or service outcomes typically struggle to find significant efficiencies in their operations. This affects one’s pricing strategies, order volumes, ability to generate additional capacity, and ability to maximize existing capacity. Generally, as volume moves up (whether for a product or service), cost per unit should at some point start to move down. This also translates to higher margins. Being able to realize economies of scale is a big reason why investors often bundle multiple businesses together.

Talent Base

Having the right people in the right roles doing the right things is a definitive driver of business value. Knowledgeable seasoned employees keep operations moving efficiently and deliver high-quality outcomes. Having a solid talent base also goes hand in hand with having effective processes and tools in place to support these employees. This includes well-documented and understood training procedures, clear job paths, and sound hiring practices. Workplan analysis is a powerful tool for assessing how work is getting done.

A pitfall that business owners sometimes fall into is making themselves too much of an integral aspect of the business. As the saying goes, “if you can’t be separated from your business, your business isn’t going to separate from you.” If an owner is the only decision maker, sales lead, or sole operator in another key role, it makes it very tough to push the value of or sell the business.

Product or Service Mix

Product and service mixes have some similarities to customer diversification. If a company’s offerings are so niched or concentrated, what happens if demand shifts suddenly or consistently over time for that offering or set of offerings? Questions to ask include “To what extent are our products or services evergreen?” and “Are there product-line or brand extensions that make sense for us to introduce?”

It’s also important to be objective about how difficult it would be for others to duplicate your offerings and as well as what the barriers to entry are and how they can be reinforced. In short, how do you keep your customers with you and your competition away via intellectual property protections or strategic actions?

Innovation

Innovation is closely related to product and service offerings. It’s easy to spot when a business spends little to nothing on product development. Products are eventually going to suffer if investments are not being made into improving their use, refining their aesthetics, and understanding who is using them. When failure to innovate causes product or service offerings to suffer, the P&L and revenue will suffer too. To quote Ayn Rand, “you can ignore reality, but you cannot ignore the consequences of ignoring reality.”

Strategic Vision

If a business owner has a clear view of the amazing direction they see for the business moving forward but can’t effectively articulate it or get others to see it, it doesn’t do much good. Would-be buyers are eyeing a positive long-term outlook. Developing and capturing a strategic vision is easy to ignore, especially in formation stages. throughout the process. When forming or evolving a strategic vision or assessing one’s products, services, and branding, Osterwalder’s work on the Business Model Canvas along with the Blue Ocean Strategy provide a great place to start for inspiration.

Technology

Not all lower- or middle-market companies are technology heavy. That may be okay in some instances, but it may also but a deterrent of value. Is the business so far behind the times that production or service inefficiencies are creeping in and sapping margins and capabilities? Are there modern techniques or technology that would help get one’s product to market faster or improve the overall buying experience? Technology investments are often punted forward to satisfy budget concerns or to calm fears of painful implementations, but those reasons should never get in the way of evaluating the potential return on technology investments.

Financial Performance Consistency

Predictable performance in positive directions naturally drives higher business value. Potential buyers and investors want to see a consistent and steady cash flow that, preferably, is accelerating over time. They also want to see that the right financial controls are in place.

Having well-prepared financial statements and reporting processes that foster objective analysis and reliable measures is also important. Their presence instills investor confidence and serves as a reliable means of comparison to other businesses. One should also be proactive about how to explain or account for anomalies that without context may be cause for concern.

Understanding and Appreciating Business Value

Each of these factors are “de-risking” strategies that address the inverse relationship between risk and value – one where risk goes up as value goes down. All of the elements outlined above are important to address whether one is looking to sell their business in the near future or not. Business value isn’t just measured by the price one could get for their business, but also by the life it allows them to lead and the time it affords them to focus on what matters most to them. One thing is for sure. The best time to get started on maximizing the value of your business is now.

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Would you like to optimize your value? Are you considering selling your business in the next several years or looking to address a specific business valuation driver? Request a Free Consultation from a vcfo expert who can help. We’ve partnered with more than 5,000 businesses in our 27 years and would love to share our expertise and experience with you.