What Makes a Business Highly Valuable?
Over more than 15 years working with SME business owners I have often been asked what is the best industry to invest in to have successful business. The reality is I have seen highly valuable businesses in most industries – and I have seen businesses that make huge losses and have very little value. Sure there are some industries where it is harder to make a profit than others.
For example the manufacture of car components CAN have a very low profitability, low growth rate, require a high capital investment. The value of these businesses can be very low or not much more than asset value. Whilst there are other industries such as IT / Software that see high profit margins, high revenue growth and minimal investment in capital. But there are also many IT companies that are not making sufficient profits, have a high level of customer churn and have a low value.
What I have come to realize is there are some features that are common amongst highly valuable businesses, and looking to emulate these features in your own business can yield a big increase in value.
1. Consistent good financial results
Value is directly related to risk – the smaller the risk of a variation in cash flows the higher the value. So if there is a positive history of above average profits and investment returns this will be valuable to a buyer. And there is no substitute for consistent EBITDA results that can be readily demonstrated.
Highly valuable businesses will often be able to demonstrate EBITDA margins that are consistently at or better than industry average, and a higher than typical return on assets.
One- off years where profitability drops can often be explained and may not impact a valuation, but consistent EBITDA and investment return is valuable.
Without doubt size counts when it comes to valuations. The EBITDA multiple can increase by as much as 20% - 30% simply from having a turnover of $5m or more rather than revenue less than $2m. This is typically because there is less risk seen in higher revenues, more indication that there are systems and processes that support the business
Evidence of consistent growth also supports a higher multiple, but typically this needs to be consistent growth over a 3-4 year period that is more than the industry average.
3. Scale (and revenue growth)
A business that possesses existing scale in terms of market share and capacity to deliver is likely to be more attractive than a business that has a small market share. But this does not always need to be a majority market share. If a path to significant scale can be shown and is supported by consistent revenue growth, then a minority market position with capacity to deliver more can be seen as very attractive. It signifies that superior revenue and earnings growth can be delivered to support a higher valuation.
Potential scale without evidence is more associated with the hope of value rather than any certainty around valuation. Many startups and software developers claim high value based on potential scale, and this MAY be true. But it may equally be NOT true – evidence is the key that helps deliver certainty and a reduction in risk.
4. Documented and effective processes and systems
Without any documented processes and systems, the standard operating procedures become a collection of Chinese whispers – everyone will have a different variation of what is expected and no one will be doing it right. In addition to this it becomes hard to consistently monitor and measure performance of different business functions, and there is always reliance on key individuals. I have seen many deals not happen and many business owners walk away from an opportunity because key information sits in an individual’s head. Write it down, get it consistent then manage and improve the processes.
I have seen on many occasions that the benefits of documenting processes is not just so everyone knows what is going on. It also helps to streamline operations, make decision making more consistent, increasing productivity and locking in efficiency gains. Documented processes unlock capacity in the business as well as lock in lower costs.
5. Structure and lack of reliance on key individuals
A management or staff structure, documented processes and systems, devolved authority to make decisions and the use of technology to do more with less resources also ensures the business is not reliant on key individuals.
Specifically we like to see client relationships spread across different people; people trained in multiple roles or at least capable of making decisions in different areas of the business; systems used to take the load off staff (such as CRMs, production reporting systems, sales reports, automated ordering etc).
6. Empowered and invested staff
In most cases staff costs are the biggest cost item in businesses these days. So it is important that staff is productive, and aligned to direction of the business. It can be a very obvious difference when looking at the financial numbers of a business with empowered and invested staff. Invariably the business makes more profit and its capacity is so much greater than its competitors.
7. Effective marketing to key customer groups.
Most successful businesses have found a niche or at least worked out the key market segments and focus the market messages on this group’s needs. Businesses that offer too many products or services, fail to target specific market segments and
The irony of this feature is that most businesses don’t do marketing well – and the area it shows is when they cannot give an accurate breakdown of revenue by market segment or customer type. This highlights they have not connected knowledge of the customer with how they should be communicating.
And in this part of the business you can never have too much information – at your fingertips. It is critical to understand the yearly and monthly revenue trends of key market segments, the effects of changes in price, website traffic and enquiries trends in order to make the right decisions on who to target and what message works best for them.
I have seen a commercial plumbing business secure 20-30% growth pa over five years because they focused on managing communication with a target set of builders and architects. I have also seen manufacturing companies dilute their efforts because they had a complex array of products or services.
8. Effective and innovative use of technology
One of the most common features of highly valuable companies is they have implemented technology in an effective way in the business. No business in the future can ignore some form of technology – whether it is reaching customers and taking orders or making processes and systems more efficient or automated.
Technology can come in many areas, but two seem to be very common: technology that enhances the customer experience or communicates with the customer in innovative ways or technology that makes the business processes more efficient and transparent. Even websites can be made more innovative these days and used to communicate or organise clients better.
Medical practices now use apps for patients to make appointments, questionnaires can now be delivered online to streamline the consulting process for financial providers. Technology can range from a unique manufacturing or service process to easy and simple ways to do business.
9. Competitive edge
Competitive edge used to be superior pricing compared to competitors, or bigger or more efficient production processes. These days it is not the “things” that make a business more competitive, but how the things are managed and implemented that make the most difference.
The most effective examples of competitive edge that I have seen have been in how staff and people are managed and how consistent reliable service can produce a lasting effect with the customer. There are companies that are managing staff more effectively through innovative workplace agreements, regular communication with staff and simple ways of measuring staff satisfaction. The results are usually more productive staff with reduced turnover.
10. Visible, transparent and empowered management reporting
After seeing hundreds of businesses produce financial reports for us to analyse, I can tell when a company is having problems by the time it takes to produce financial reports and the state those reports are in. Sometimes as part of client discussions I will ask the business owner what their overall revenue was last year, or what it is at the moment. When they can’t tell me or can’t locate a report quickly that will give the answer then I usually know there will also be financial performance issues.
Typically these symptoms mean the business owner does not review performance regularly, they do not put in place proactive corrective actions and rarely do staff understand what is happening. As a result the profitability is often lower than its peers who have implemented a visible transparent reporting system.
Having more of these features than less will increase the attractiveness of your business, lead to a higher EBITDA multiple and an increased valuation. It is also true that many of these features will lead to increased EBITDA of itself, and thus lead to a higher valuation.
I am certainly not saying that these are the only features that make a business highly successful – there will be many more that are specific to some industries and not to others.
I am also not saying that you need all of these features.
However I am saying that if you do well with some of these features then it is more likely your business will be MORE highly valuable than that of your competitors.
If you want to explore how attractive your business is then contact us here for a no-obligation discussion.