For most business owners and managers, the market value of their company is an enigma. The idea of any buyer assigning a cold, dispassionate number to the product of your organization’s years, or even decades, of collective sweat and tears can be difficult to fathom. The methods that seasoned acquirers use to value businesses can also seem to be mysterious, particularly when similar businesses are assigned very different values. Furthermore, buyers vary widely in their valuation perspectives and methods. But there are fundamental drivers of business valuation that most sophisticated buyers consider. Your company’s market value ultimately will be determined by the price a buyer is willing to pay. Getting acquainted with these key business valuation drivers can make you better armed to maximize your firm’s equity value.
1. The value of your business is tied to how buyers perceive its financial risk and reward. The more future potential reward (i.e., future expected cash flow) a buyer perceives, the higher that buyer will value your business. The less stable, “turn-key,” and well-oiled a buyer perceives your business to be, the lower it will value your business.
2. Future potential reward is driven by expected future cash flow. This primarily includes expected EBITDA (earnings before interest, taxes, depreciation, and amortization), expected working capital investment, and expected fixed asset investment (aka capital expenditures, or cap ex). Surprising to many, your existing debt load is not meaningful in these expectations, as buyers can change your capital structure as part of the transaction.
3. The higher your expected future EBITDA, the higher your valuation, all else being equal. Things you can do to drive expected EBITDA higher include demonstrating sustained sales growth, market share gains, and improvement in gross and EBITDA margins, as well as clearly articulating your organic and acquisition-related sales growth opportunities.
4. The lower your expected cap ex and working capital investment (often ballparked as receivables plus inventory minus accounts payable), the higher your valuation. Ways to decrease your working capital investment include cutting your average AR days outstanding, cleaning up bad debts, increasing your working capital turns, removing obsolete inventory, and not paying vendors faster than necessary to earn your discounts (also, don’t pay your vendors faster than necessary just because you can). Lower expected working capital investment means higher expected cash flow.
5. Things you can do to lower expected cap ex include keeping your facility, equipment, and rolling stock well-maintained as well as investing in fixed assets prudently. The Taj Majal of facilities doesn’t translate into a higher value for your business, unless it also translates into higher future expected cash flow.
Actions that lower perceived business risk include having a strong management team in place (the more your business revolves around you or another “key man,” the greater its perceived risk); a quality employee base with low turnover; low customer concentration (the more tied to a few key customers your business is, the higher its perceived risk); solid customer credit, evidenced by low AR days outstanding and low bad debt; strong competitive position, as shown by a leading market share position in your target market; strong financial and operating controls; organized budgeting, monthly financial reporting and reviewed or audited financial statements; and well-organized and maintained inventory, equipment and facilities. They’re all signs that your business is tightly run with less required “fixing.”
Matt Ogden is managing principal of Building Industry Partners LLC, a building products-focused private equity investment and M&A/debt advisory firm that is a co-founding equity sponsor of US LBM Holdings. E-mail: email@example.com. 214.550.0405