In part one of our blog series on business value, we identified key drivers that underpin a company’s worth. Just as certain factors drive value, the lack of them, or their inverse, can drain value from a business, and this can have an impact far beyond daily operations and short-term profitability.
Keep in mind the same threats and weaknesses that keep a business owner up at night will be scrutinized should the business ever be up for sale. Value draining traits or problems in a business will be uncovered during a potential buyer’s due diligence process, and they can decrease perceived value and ultimately, the asking price. After all, value is in the eyes of the beholder, regardless of whether the price is rational.
Factors that Decrease Business Value
Understanding what could be decreasing the value of your business will allow you to stop the bleeding and position it for long-term growth and marketability. Let’s take a closer look at some value drainers across four key areas of a business.
Buyers like steady, predictable cash flows and a strong history of profitability. Companies with low levels of profitability, unsustainable earnings, low levels of working capital, heavy debt load, and flat or declining revenue and “earnings before interest, taxes, depreciation and amortization” (EBITDA) are less appealing to potential buyers. Likewise, a business with poorly maintained and presented financial information is less attractive to a potential buyer than a business with strong financial controls and clean, detailed financial information, including sales by customer and product margin data.
Buyers like value they can see, which often is the presentation of financial information without significant adjustments for extraordinary, non-recurring, personal and discretionary items.
While strong leadership in a business is important, too much reliance or dependence on key management can be a value drainer for businesses. Potential investors may be disenchanted by a business owner unwilling to relinquish control or customer relationships. On the other end of the spectrum, the lack of a strong management team committed to staying on post-transaction could detract from perceived value if a potential buyer does not already have a strong team in place to manage the new acquisition. The value of a business also can suffer due to mismanagement of a business’ intangible and tangible assets, such as incomplete or disorganized operations, policies and procedures; poor maintenance of infrastructure; outdated technology and fixed assets; and labor force/union issues.
3. Supply Chain/Market:
Whereas the existence of strong vendor and customer relationships is undoubtedly a value driver, too much reliance on individual suppliers or major customers can have the opposite effect. The lack of diversification, whether it be from a product, asset class, industry, geographic, vendor or customer standpoint, is a potential value drainer. Additionally, a bleak industry outlook with limited growth potential could result in declining future cash flows, which has a direct negative impact on business value.
Excessive legal costs and regulatory violation penalties are drains on cash flow, and the excessive occurrence of lawsuits or regulatory violations can be red flags for a potential buyer.
The unknowns and future risks of a business are among the largest fears of a potential buyer. Even though business owners do not have crystal balls, it is critical to review the current state of their companies for the presence of these value drainers. While some of these issues can be addressed quickly and easily, others can take several years to fix, such as a heavy dependence on the owner or a lack of a strong management team.
RKL’s experienced team of business appraisers can develop a strategic plan to minimize your company’s value drainers. We can help drive value in your business and make it more attractive on the acquisition market. Contact us today to get started.
Contributed by Steven M. Frank, CPA/ABV, Manager in RKL’s Business Consulting Services Group. Steve provides business valuation, litigation support services and financial analysis to clients, along with conducting special projects including cash flow modeling and assistance with acquisitions and sales of closely-held businesses.