Setting your sights on value
Wednesday, August 24, 2011/
If there’s one target every small business should have in their sights, it’s business value. Too often I come across business owners that focus on profits or revenue.
While these measures are important, they aren’t long-term drivers of what should be the ultimate goal of every business owner – to have a saleable business that provides a high return on investment and effort.
Business value is what business owners should be focusing on. It is a measure that addresses all the key things you need to get right to have a successful business.
It is a long-term target that provides business owners the ultimate reward; a successful exit as well as flexibility and choice around when and if they should sell.
Here are my five steps to maximising the value of your business:
- As a business owner you should start with a mindset that you are building your business to sell. This doesn’t mean you have to sell it, but if you don’t, you’re effectively buying it yourself.
So make sure your business is worth owning. This mindset will give you a laser sharp focus on the key things you need to get right.
By making the business “sale ready” and by maximising value, you will have a business that is worth owning and one that is also worth selling.
- Set a value target for your business and a timeframe to achieve it.
- Calculate the current value of the business and get an understanding of what the drivers of business value are. You may need some professional help in doing this but it is well worth the exercise.
- Calculate the gap between the current value and your target and understand what you need to focus on to bridge the gap. Develop a plan for each of the key value drivers that will see the business hit its target value.
- With your plan in place, focus on the key value drivers by putting in place a monitoring system to measure how you are going in each of these areas.
The key value drivers of any business are:
- Free cash: This is cash that is uncommitted and available within the business to be directed as the owner chooses.
It’s cash that can be reinvested or taken as dividends by the business owner. Having free cash available makes the business less reliant on debt to fund its growth and operating activities.
Companies that have free cash and minimal debt are more highly valued.
- Profitability: Profits are what generate the financial return on investment. Therefore higher profit generally means higher value.
But it is just not the amount of profit that is important it is also the profit margins.
How do your profit margins compare with industry benchmarks? All other things being equal, a business that has demonstrated higher profit margins than its competitors will be valued more highly.
- Growth: Growth is perhaps the number one driver of value and an established pattern of profitable growth is attractive to potential buyers and can add a substantial premium to the purchase price of a business.
Those businesses with a strong competitive advantage will grow faster than the industry average and generally will be worth more.
Operating in a growing and expanding industry also adds to the growth prospects of the business.
- Risk: Most people shun risk and uncertainty. Business needs to avoid it as well. It’s not possible to remove all risk, but reducing and managing your exposure limits the likely impact on both the continuity of the business and its value.
The key business risks faced by most small businesses are:
- Heavy dependance on business owners.
- Reliance on one or two key customers for most of the revenue.
- Lack of quality and depth of management.
- Low barriers to entry.
- A large number of competitors.
All these risks create significant exposure for the business and lower its value.
If you get all these bases right, you’ll have a more valuable business, able to provide you a solid return on your investment, now and in the long-term.
The other benefit is that a business that ticks all the value boxes for growth, profitability, cash and risk means you have a business that you want to own and are more likely to enjoy running, and that’s worth something.
Marc Peskett is a director of MPR Group a Melbourne based firm that provides business advisory services as well as tax, outsourced accounting, grants support and financial services to fast growing small to medium enterprises. MPR Group is a member of the Proactive Accountants Network. You can follow Marc on Twitter @mpeskett