What are Valuation Drivers?
Valuation drivers refer to factors that increase the value of a business in the event of a sale opportunity. Business owners need to consider essential factors to increase cash flows, as well as reduce risk, thus enhancing the overall value of the company. They need to start monitoring their company’s value a number of years before they consider an exit.
It is essential for a private company owner to recognize and appreciate the valuation drivers that will improve cash flows and reduce the risks linked to the business. There are numerous value drivers that can be attributed to a business, some of which are specific to particular industries. Below are some of the universal valuation drivers.
Examples of Valuation Drivers
1. Economies of Scale
The costs per unit typically go down with an increase in production output. It may be through the spread of capacity costs over bigger volumes or through quantity discounts. A company should exploit the internal economies of scale well that would help it grow. Companies can also realize extra economies of scale by entering into a joint venture, consortium, or outsourcing to improve its buying power, as well as lower expenses.
Small companies without large monetary resources usually lack adequate resources for research and development, thereby finding it difficult to match the changes in technology in their markets. Most of the time, such companies are forced to allocate resources to a few product development projects or incur a lot of expenses in the near future. The result is obsolescence of the product or service, poor growth, and loss of market share.
However, larger companies can show technological expertise better through the development of products that address emerging customer needs, luring customers into choosing modern high-performance products.
3. Product and Service Offering
Even though specialty entities usually develop their strength by concentrating on niche fields, such focus can lead to risks due to overdependence on a few markets and lack of diversification. The largest customers of some of these businesses may adopt a policy to only deal will suppliers offering a wide variety of products, compelling them to either sell out to a bigger company or expand their product offerings. Companies should strive to develop a mix of offerings.
4. Access to Capital
Smaller companies usually have limited access to equity capital and debt. The business managers and owners of such companies need to evaluate the type of capital that they would need to achieve their goals. They need to know how the company is leveraged currently, whether shareholders may be required to provide personally guarantee loans or equity, or whether they should bring in an external investor and issue preferred stock.
5. Financial Performance
Through financial analysis, a company can measure trends, identify its liabilities and assets, and compare its condition and financial performance with similar companies. Financial statements that are internally prepared may impede the assessment of performance by management, leading to the possibility of prospective buyers questioning the quality of the data.
6. Skilled Employees
Skilled human capital is vital for any organization. Company employees contribute skills, creative abilities, experience, and knowledge to the business as well as the health of the company’s culture. The employees will determine the effectiveness of production and service delivery.
7. Solid Customer Base
Having a customer base that is solid and widespread is important for the continuing viability of a company. When businesses grow and flourish by only providing service to their largest customers, it may increase their dependency until where a huge portion of the revenues comes from very few customers. Businesses need to manage the distribution of customer concentration to minimize the risk of losing a substantial source of the company revenues.
8. Market Environment
Businesses are usually influenced by the developments and economic trends in the industries that they operate in. The company’s management needs to develop a good understanding of the impact of economic factors on their industry, their market share and market position, and their unique and niche offering.
9. Branding and Marketing Strategy
Marketing refers to the link between the needs of customers and their response to the products or services of a company. A company with strong branding will improve its sales through an increase in market recognition and also give it a clear direction that helps enhance operational efficiency. A company should tie its brand to its mission and strategy direction and be aware of its sales and marketing shortcomings and capabilities.
10. Strategic Vision
A large number of companies simply formulate yearly budgets without trying to put together long-term business plans or forecasts that are in tune with the needs, tenure, demands, and demographics of their customers. Since valuation is inclined towards future prospects, the management of the company needs to adopt a strategic vision if they want to create value.
Getting a company ready for sale usually take a number of years, particularly if you intend to yield maximum value for your hard work. Continuous assessment of the key valuation drivers of your company is central to its success since it will not only improve the valuation of the company but also lead to a profitable and more efficient company in the long run.
As illustrated above, there are numerous valuation drivers that each business owner needs to focus on to avoid leaving money on the negotiation table when they want to sell.
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: