Posted on November 26th, 2019 in Business Valuations

Maximizing Business Value

Outside patio of a restaurant

We are often asked “How can I maximize the value of my business?” This can be of particular concern to a business owner who is nearing retirement, has been informally approached by interested purchasers, or is otherwise interest in selling their company.

While a proper valuation of the business requires careful analysis of the business and its unique attributes, there are several fundamental factors that serve as an underlying basis of most business valuations. Through an understanding of these factors and their impact, a business owner may be able to make adjustments to the operation of their company in order to maximize value on its eventual sale.

Discretionary Cash Flow

A key factor in the value of most businesses is the after-tax cash flow generated. Generally speaking, the greater the after-tax cash flow a business generates, the greater the value of the business.

It should be noted that the after-tax cash flow frequently used in a business valuation reflects the after-tax cash flow associated with the investment in the company. As a result, the after-tax cash flows are adjusted to remove the fair value of managerial services. The cash flows also consider the impact of capital expenditures and working capital requirements.

While many people may focus on the growth of gross revenue, believing this is what drives the value of a business, this growth will not necessarily lead to an increase in the value of the business. It is important that consideration be given to the costs associated with the additional revenue, including any additional capital expenditure and working capital requirements.

Careful management of the company’s costs, capital expenditure and working capital requirements may have a significant impact on the value of the company.

Risk

Another key factor in most business valuations is risk. A prospective purchaser will carefully consider the risks associated with realizing the expected after-tax cash flow. This may include:

  • An assessment of the critical success factors of the business. How successful is the company in the areas that are deemed critical to its success?
  • Revenue and/or cash flow stability – Does the Company have a history of stable revenue and/or cash flow? Or are there significant fluctuations year to year?
  • Customer concentration – Is the company dependent on a few customers? Or does it have a well-diversified customer base that protects it from down turns in specific businesses and/or industries?
  • Key employee – Is the company reliant on one or two key employees? Could the business continue to operate and succeed without them? Or are key responsibilities transferable to other employees? Are succession plans in place?
  • Differentiation and competitive advantage – What distinguishes the company from its competition and is that expected to continue?

Generally speaking, businesses that are considered higher risk have a lower value than those with a lower risk. Careful management of the Company’s risk factors may have a significant impact on the value of the company.

Assets

The fair market value of the net assets (assets less liabilities) of a company can have a significant impact on the value of the company. In instances in which the after-tax cash flow of the business is not significant, the fair market value of the net assets may be used as a basis to determine the fair market value of the company. In most cases, the fair market value of a company is expected to be no lower than the fair market value of its net assets.

The fair market value of the net assets may also impact the risk assessment of the company. In instances in which the fair market value of the company is based on a multiple of its after-tax cash flows, the ability to realize the fair market value of the net assets by selling off the assets serves to reduce risk associated with the purchase price when compared to a company that has little or no net asset value.

Careful management of the company’s net assets may assist in maximizing the value of the company.

The valuation of a business involves a careful analysis of the business, its unique attributes and many factors that impact fundamental factors such as discretionary cash flow, risk and assets. Please contact DJB if you would like assistance obtaining a better understanding of the value of your business and the factors that may help to maximize its value.

Article originally published in: FSAT News: Fall/Winter 2019