Every business has the potential to be great. But the reality is that most never last ten years. Sadly, those firms that do make it past the first ten years earn little more for their owners than they would have made working for someone else. In fact, if the owners charged full price for the value of their own work and made a charge for the cost of capital they have invested, only a handful would make a profit. In other words, most people are actually destroying their own wealth.
There are two reasons for this appalling phenomenon:
1. Business people tend to pursue a “me too” competitive strategy;
2. Execution of that strategy is at best ordinary, and at worst appalling. What, then, are the factors that increase the value of a business? Here are a handful of the “Value Drivers” that business appraisers consider when valuing a business:
- Loyal Customers and Employees. Turnover in customers or employees can cost a business a lot of money and valuable time. Loyal customers represent quality revenue, and loyal employees can create higher levels of customer satisfaction on a consistent basis.
- Systems. A business is nothing more than a bundle of processes. The level to which the business is systematized will have a dramatic effect on the marketability of the business. A business that relies on the owner being there all the time, for example, is simply less marketable than a business that can run independently of the owner. The development of systems is critical to creating a business that really works.
- A Unique Core Differentiator. Also known as a Unique Selling Proposition, a Unique Core Differentiator (UCD) is a means of differentiating a business from its competitors. Having a UCD means that the business may be less dependent on pricing as a strategy for growing its business. A UCD might be the way a business packages its products or services, or the way it promotes itself in a way its competitors cannot match.
- Customer Focus. A business that obtains regular, candid feedback from its customers (and acts on that feedback) will generally have more loyal customers. In addition, the business will focus on what its customers really want, and what they’re willing to pay for. All together, these factors can increase the profitability of a business, and therefore its value.
BUSINESS VALUATION APPROACHES
A company’s value is derived from its future benefits. Such benefits cannot be measured with absolute certainty, so different valuation approaches have evolved. There are three main approaches to valuing a business: the Income Approach, the Market Approach, and the Asset Based Approach.
- Income Approach. This involves estimating future income and then discounting the income using present value techniques. As an alternative, the income can be capitalized using an appropriate capitalization rate.
- Market Approach. This approach assumes that the value can be estimated using data from recent sales of comparable companies. Using this approach involves extensive searches for comparable guideline companies, which is often difficult to accomplish.
- Asset Based Approach. This approach assumes that the business’ value is indicated by the cost of replacing it, less an allowance for deterioration or obsolescence of the assets. This method is generally applied to companies with little value beyond the value of their tangible assets, or when valuing individual components of a business enterprise.
In most valuation projects, two or more valuation methods are selected. The type of valuation methods selected depends on the purpose of the valuation, the type of company, the available data, and other factors. The professional judgment and technical expertise of the valuation professional is the most important factor in selecting a valuation method. Paul Svendsen works with local businesses improving their performance. He also is an adjunct instructor at COCC. He can be reached at 389-4740.
