Business owners can improve the value of their companies without any outside investors, according to a study conducted over the last two years on business value creation. The study derives results from consideration of industry benchmarks and a Private Capital Market valuation model applied to data gathered over the last two years. The model is based on input from over 835 privately held business owners who have received written offers for their companies during this period.
The study helps conclude that there are four different levels of privately held companies. Those with: Below Average Profit, Average Profit, Above Average Growth/Profit, and Low Risk Companies. These factors – and the company’s industry, size, growth, and risk – are all primary drivers of valuation. While valuation is a function of profitability, the valuation multiple is relatively independent of profit or profit margin and the valuation multiple is most influenced by the company’s investment risk more than anything else.
The real opportunity for an owner is to move up the value chain from one level to another. Moving from an Average Profit company to a Profit Leader improves value by 2.7X and becoming a Value Leader by another 2.2X for a combined improvement of 4.9X.
Moving up the Chain
So how does an owner move up the value scale from being an average company, to a Profit Leader, and ultimately to a Value Leader? How long does it take and what kind of Investment is involved?
Going from an Average company to a Profit Leader. In general, there are four major factors that contribute to achieving profit leadership (defined as having margins in the top quartile of the industry):
- Optimizing product and customer mix
- Continuous Cost Reduction
- Customer value based pricing
- Business Process Optimization.
Most business owners appreciate the benefits of continuous improvement with the first three items. But the kinds of improvement that a good Business Process Optimization effort can produce over a two-year period can significantly impact Total Cycle time in the Order-to-Cash process, New Product Time to Market, Delivery Lead Times, Operational Productivity, Revenue Increase, Defects, and Margin.
Becoming a Value Leader. The last step in the value enhancement process for an owner is focusing on those things that impact value in the eyes of a potential buyer. While size and profitability are important, other factors need to be considered as well. An investor must consider the risks involved in creating a stream of profits that can be counted on to generate an acceptable return on what is invested. Investors have lots of options for where to put their money and the attention is going to be on the places that provide the best return for the least risk.
Reducing the risks involved with generating a future stream of profits for a privately held lower middle market company is what gives rise to valuation multiples that take a Profit Leader from a 3X multiple of operating income to a Value Leader with a 5X multiple.
Most investment models consider at least eight areas that contribute to becoming a Value Leader. Each area has a number of additional dimensions and levels that give it character and better definition. The study shows how the sensitivity of an acquisition model applied to the manufacturing industry can improve value. The model considers the risks of a private company investment as a key component. The value model used in this study includes variability around 25 different components contained in eight major categories including: Financial performance, Growth & Scalability, Concentration Issues, Asset Management, Recurring Revenue, Competitive Barriers, Customer Satisfaction, and Management Strength.
The results show that Valuation Multiples for Average Private Companies range from 2.5 – 3.7, 2.7 – 3.8 for high profit companies and up to 5X for high value companies.
The Benefit of Benchmarking
So what’s important to maximizing value? With a business, Size, Growth, Cash Flow, Risk and Timing are all important. If you are a seller, nobody is going to pay for what you put into the business, they will only pay for the value they perceive they can get out of it. Even most strategic buyers have their own unique reasons for assigning value and they are often related to either the growth or cost synergies that can be extracted from the acquired business as it is integrated into the owner’s existing operation. Strategic buyers may or may not share some of those synergies with the seller in the form of an increase in purchase price.
The good news is that based on the application of benchmarking, Business Process Optimization and investment modeling for lower middle market companies in the commercial print space, there is significant opportunity for owners to increase the value of their companies. If you haven’t undergone a business process re-engineering evaluation effort recently it might be time see what can be gained by getting some help in this area. There are also a number of M&A professionals that can help you understand all the investment risks associated with your business today and how to minimize them in the future.
Conventional sports wisdom states that offense wins games but defense wins championships. In business when it come time to sell, profit leadership will get you a good price but a business with minimum risk will capture the ultimate premium. Doing both is “a grand slam”! Making it happen takes longer than ordering up a breakfast item at Denny’s but the return is nowhere near comparable.