People value businesses for many different reasons, such as insurance, resale, or taxation. To some extent, the most significant factors vary depending on the type of business. Most people assume valuations are all about numbers, but that’s not the full picture. The numbers are obviously a key piece, but valuators consider other factors that many owners overlook.
Let’s look at three factors most don’t think of, but have a significant impact
1. Owner Involvement
One thing that makes selling and transitioning a business challenging is the question of “is this a viable business without the owner”. A new owner must consider this since the presumed goal of buying a business is to continue it and produce profits from it.
Often owners, particularly founders, have become bottlenecks for growth in their own company. Most don’t even realize it. Without learning to properly staff and delegate they’ve worked harder and harder, and longer and longer to produce growth. That type of work isn’t something a new owner may be interested in or even capable of.
Another factor owners often miss is how much of the customer base sees them as a client of the person rather than the company. The new owner must consider the fact that they could lose a significant portion of revenue if clients don’t want to stick around after a sale. While some level of attrition is to be expected, it can be untenable if too many clients are committed to the owner and may leave after the sale.
2. Recurring or Re-occurring Revenue
Nearly every business today is working to build some sort of recurring or re-occurring revenue. It has become the holy grail of business in some regards. And, rightfully so. It makes sustainability more attainable. It allows businesses to survive economic challenges, etc. There are plenty of reasons it’s fruitful. It’s why you see so many examples of it.
For example, HVAC companies routinely sell “service contracts” to consumers now. It may include annual inspections, minor repairs, and other services built into one contract fee. With enough customers on a plan like that they can build a foundation of revenue where in the past they had to rely on new service calls, new product installs, etc exclusively.
Of course, not every business has the potential for significant revenue like this. Consider a home builder. Their revenue comes in large chunks, and finding ways to make it recurring is challenging. A CPA firm experiences re-occurring revenue by the ability to bill each quarter for quarterly filings and annually for tax prep. Whatever your business is able to do, some level of recurring or re-occurring revenue is a positive factor in a valuation.
3. Top Customers Revenue Share
One of the questions owners are most surprised by when we’re preparing for a valuation is, “what percentage of revenue comes from your top 3 customers?”. Consider this, if a company has 3 customers they’re very proud of, and they generate 75% of their total revenue then presumably revenues could drop by 25% or more overall with the loss of just one of those great customers.
Now, for many businesses, this produces a conundrum. When you have a small number of really great customers, you have to find a balance between relying on them exclusively and committing resources away from them to serve other, smaller clients. That’s no easy balancing act, but it’s certainly a worthy one. Of course, having 3 really great customers is a fantastic problem to have, but relying on them for more than 30-50% of revenue can leave you in a challenging position and affect your valuation.
Summary
In summary, being aware of these 3 overlooked valuation considerations give you objectives to raise the value of your company. If you’re an owner with their hands in everything and customers who rely on their relationship with you begin to shift those responsibilities and relationships to other trusted team members. Perhaps you haven’t taken the time to consider new avenues for recurring revenue. Or maybe you’ve been too dependent on a handful of really great clients and need to expand your client base.
Potential buyers will consider these factors right alongside the numbers themselves, so they’re worth the time to consider. In the meantime, having a valuation that shows you where you stand gives you a great tool to build on, as well as a tool to plan your company’s future. At Congevity we can provide you with a valuation and discuss ways to improve it in the future.