By Michael Torney, J.D., CFP®, LL.M., CEPA
Business value drivers are the underlying factors that influence what a company is worth today and what it may be worth in the future.
The factors impacting a business’s value vary significantly, including things such as:
- The business’s financial standings
- The strength and efficiency of its operations
- The reliability of its leadership team and customer base
- Brand, culture, and intellectual property
Together, these drivers often shape how others (including potential buyers, investors, or lenders) assess risk and evaluate the business’s long-term potential. When a business owner understands what factors drive the value of their business, they can more effectively improve and protect those drivers. This knowledge can be especially critical in the face of a liquidity event or as owners make decisions around future business development and investment.
Financial and Economic Drivers
Rather unsurprisingly, businesses with consistent revenue growth, predictable cash flow, and strong profitability tend to command higher multiples because they often present lower long-term risk.
Healthy margins and disciplined cost management show that the company not only generates earnings but can sustain them through business cycles. Meanwhile, a proven track record of scalable operations can indicate more potential for sustainable long-term growth (without proportionally increased costs). Collectively, these drivers can help quantify what the business is worth to sellers and other stakeholders.
Structural and Operational Drivers
A business’s internal infrastructure can determine whether its value is realistically transferable to a new owner or successor. When a company’s success relies heavily on the owner or their operations are informal and unstandardized, for example, these challenges may be reflected in a lower valuation.
By comparison, organizations with documented processes, defined roles, and strong internal controls may prove more resilient under changing ownership or amidst other shifting environments—making them more valuable to buyers.
An effective line-up of leadership can be an especially important driver, as it indicates high-level responsibilities are spread across multiple capable people. For buyers, this can create less perceived key person risk, since the company’s operations aren’t solely dependent on one individual (often the owner).
Similarly, a concentrated customer base (meaning one or a few clients represent most of the revenue) can negatively impact a business’s value since losing just one or two of those customers could compromise the entire business. A more diversified base can help protect the business long-term and positively impact its valuation.
Intangible & Relational Drivers
Some value drivers are harder to quantify and define, but they’re likely the things that make your successes hard (even impossible) for others to replicate.
These can include your:
- Human capital: your ability to attract, retain, and develop talent
- Social or brand capital: your reputation and culture
- Customer capital: your customer loyalty and deep relationships
- Structural capital: your intellectual property, proprietary methods, and competitive advantages
Combined, these drivers help create a “stickiness” within your industry or marketplace. Even though they may not appear directly on your business’s balance sheet, they can significantly shape how outsiders perceive the durability and potential of your company.
How to Manage & Maximize Your Value Drivers
Despite what some business owners believe, understanding your value drivers (and finding opportunities to maximize them) shouldn’t wait until you’re ready to sell the business.
Every five years or so, business owners should consider obtaining an enterprise evaluation assessment (EVA) from an independent third party. With an understanding of what drives business values in various industries, this company can provide a comprehensive look at what your business may sell for today, what’s the industry standard range, and what you could do to increase the valuation over time.
While these evaluations do cost you and your leadership bench time, energy, and some expense upfront, the knowledge and understanding they provide are critical to being an informed business owner. Even if you’re not interested in selling now, you can leverage this information into a blueprint for where you need to invest your time and resources moving forward to maximize future value.
For example, let’s say the current industry standard for your business is to sell between 5x and 8x your EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). You’re considering selling over the next 5-10 years, but you don’t know what your business is currently worth. After a third-party valuation, you learn that your business today could sell for about 6x EBITDA. While well within the industry standard, there’s still an opportunity to drive the value higher. Now, with the assessor’s recommendations in hand, you must decide if it’s worth the risk of investing time and energy into making these improvements (in the hopes of yielding a higher sale price in several years) or to stick to the same playbook you’ve been following so far.
How Can Business Owners Drive the Value Higher?
As we mentioned, business value drivers appear across all aspects of your business, meaning there is no shortage of opportunities to increase value strategically. Before making improvements, however, consider obtaining a valuation to really understand where your efforts can make the most impact. Whether you need to diversify your customer base, reduce certain risks, or improve your operations, follow an intentional strategy based on what will help increase your business’s value long-term.
Your business is your most significant asset, and understanding its value drivers gives you the power to shape the future—rather than react to it. If you have questions about business valuation drivers or would like to learn more, simply fill out the form below to request advisor outreach.
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