Many successful businesses start with a period of strong initial growth, but eventually level off as they mature. When that happens, it is common for the entrepreneurial spirit to diminish as the company’s leaders tend to focus less on the value proposition that inspired the initial growth period and spend more time on the day-to-day operations. Along with maintaining current operations, it is critical for leaders to continuously assess the valuation factors that impact their business on a regular basis.
Smart Business spoke with Brian J. Sharkey, director-in-charge of the business advisory group at Kreischer Miller, about what drives value in a business.
How is business value determined?
In its most simplistic form, the monetary value of a business interest is based on the future expectation of cash flows, which is why most valuation drivers revolve around the ability to replicate sustainable cash flows into the future for as long as possible.
As a result, the fundamental question every management team should ask themselves is: ‘What drives the value proposition for this business?’ Most of the time the answer will gravitate towards the ability to put forth a profitable product or service that customers will return to. But it’s also a bit deeper than that.
Value creation can also be achieved with improved processes. By implementing more streamlined and efficient processes, in the course of producing a product or providing a service, the company will have the ability to offer a lower price than competitors while still maintaining similar or better profitability. In addition, the company will be able to increase its market share, which will improve brand recognition.
How are brand recognition and value linked?
For most businesses, the value in brand recognition is immeasurable. Brand recognition is what keeps customers coming back to a product or service; without it, a company loses the ability to generate those recurring revenues, which are critical in measuring a business’s value.
Ask the management team how customers perceive value and whether the business is meeting those expectations. This concept goes beyond just quality and value, and into evaluating the overall customer experience. A business can have the best product or service out there, but if the customer experience is awful when dealing with the company, then none of it will matter and customers will look for alternatives.
What do employees contribute to a business’s value?
Employees are the most valuable asset of a company; an asset that does not show up on a balance sheet. If a business neglects to develop and retain those individuals who are critical to the organization, they can be recruited by a competitor who is looking to get a leg up. The knowledge and skill sets of a workforce are difficult to replace without significant time, costs and effort. Having to constantly retrain or develop new members of management is a distraction from the other activities that should be the focus of the company.
How can business leaders continue to drive up their company’s’ value?
Once a business becomes mature, as much attention needs to be paid to protecting the value as to creating value. This starts with never being comfortable, as complacency generally leads to declining value or vulnerability from competition. The companies that continue to succeed and build value are the ones that are constantly investing in process improvement, innovation and product development with aspirations of finding that next big thing. By doing so, they are hitting on many of the drivers that positively impact valuation, such as creating a recurring revenue model, diversifying their product or services, creating their own intellectual property, maintaining state-of-the-art facilities and employing top-notch people.
Focusing on tasks and objectives that increase company value will not only drive short-term results, but more importantly will also allow owners to maximize the valuation upon a future sale of their equity interest in their business. Even though a sale may not be in the immediate future plans, it is still wise to focus on valuation factors in the event that an unexpected, unsolicited offer is made.
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