When business owners consider their company’s value, they usually think of how much the company could sell for today. When maximizing that value for a future transaction, owners will focus on driving revenue and profitability growth. This transaction value is not the most controllable value measure, as revenue and profitability growth are not the drivers that maximize a business’s true value.
Value has countless definitions that vary by the assessment purpose. Fair value, market value, and fair market value are common valuation standards, but all have different meanings and uses. Other value types include owner value, investor value, collateral value, synergistic value, book value, and liquidation value.
So, what should a business owner prioritize? The best, most practical, and impactful way to think about value is to view it as a prophecy of the sustainability, predictability, and transferability of future cash flows. Understanding the prophecy perspective will effectively refocus your business management style.
- Look Forward, Not Backward.
Value has little to do with the past. Companies often use the past as a proxy for the future when they lack a well-developed and clearly articulated plan for the future. Basing value in the past can be detrimental to a growing company’s ownership, especially if a lender, investor, or acquirer is in the defining process. You can overcome this value detriment by developing a detailed strategic plan. Over a 2-3 year period, demonstrate that the company has the discipline to execute this plan. - Focus on Quality to Minimize Risk.
Future cash flows must be sustainable and predictable. They should not be based on revenue from a concentration of customers, one-time large orders, or business that does not align closely with the company’s growth strategy on order size, geography, or core competencies. Sustainability implies high underlying quality of your company’s assets, ranging from products and services, leadership, organization, systems, processes, people, financial stability, facilities and equipment, scaling capacity, and more. Company weaknesses are potential growth constraints and create risk in future cash flows. Risk quickly depletes value. In business valuations, risk and quality have an inverse relationship; the higher the underlying quality of the business, the lower the risk. The lower the risk, the higher the value. Mitigate risk by understanding, assessing, and strengthening your company’s underlying weaknesses that cap future growth. - Value Your Team.
Future cash flows must be transferable. The company’s intellectual knowledge must be institutionalized horizontally, not concentrated vertically in the owner or a small team. Risk greatly increases if a key leader’s departure or inability adversely impacts the company’s future cash flows. Develop a leadership team and an operational succession plan for every key position in the company to overcome this risk.
Prioritizing these key drivers will maximize your company’s intrinsic value, or the value independent of external trends in the volatile transaction market. Most private companies can double or triple their value over a 2-5 year period by focusing on intrinsic value. Maximize your company’s intrinsic value to position yourself highly on the transaction market range, no matter when that future event arrives.
