Top 5 Factors Affecting the Value of Your Company

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This week we are examining some of the most commonly known factors that will most likely affect the end value of your company during the valuation process. Fundamentally, these factors can be grouped by either internal and external in nature. Internal factors are those that fall under direct jurisdiction and control of the company’s integral operational and decision-making body. External factors are those that are out of the direct reach and control of your business decisions, usually manifested as market forces. Before we jump into the discussion of these main factors, let’s define what the valuation process is, why it’s important and what are some of the known methodologies for performing one.

Business Valuation

Business valuation is the process of determining the economic value of a business or company. It can be used to determine the fair value of a business for a variety of reasons, including sale value establishing partner ownership and even divorce proceedings. Owners will often turn to professional business valuators for an objective estimate of the value of the company1. Business valuation is typically conducted when a company is looking to sell all or a portion of its operations or looking to merge with or acquire another company.

Different methods of valuation are often used to determine different key performance indicators of a company to portray a clearer picture of the advantages and pitfalls of the evaluated company. For example, a discounted free cash flow method of valuation is used to determine the expectations regarding the future performance of the company and its ability to generate cash flows with the available company’s resources. Different methods of valuation are essentially used to compare and optimize the end value of a business. Using more than one type of valuation methodologies can increase the precision, scale, and comprehension of collected insights which in turn help maximizing the value of your company.

Internal Factors

Independent of the type of valuation method chosen, there are certain inherent elements to any business that will affect its end value. We will begin by covering several internal factors, or those that can and should be anticipated and dealt with by any company planning a valuation process.

Information quality – remember that garbage in means garbage out! A quality valuation would require quality information input provided by credible and secure sources. It is necessary that all the company’s past and present financial data is comprehensive and accurate. Only by ensuring information quality consistent with the strategic approach, will you be able to make a reliable projection of said data and reach realistic conclusions about the company’s value. The bottom line is – the more information you have about the business model and the variables that affect the company’s activity the better the quality of the valuation.

Growth prospects – this factor determines the amount of potential a business can to grow in the future. The growth prospects of a given business aren’t necessarily dependent of industry performance but can be if the industry is undergoing disruptive changes or if the nature of the business is highly interdependent with market prices, e.g. income statements of Airline companies can vary based on the price of oil for the given time period. Hence, if your business model is scalable and has high growth potential, or perhaps your industry niche is likely to see significant growth in the near future, then these factors are likely to increase the value of your business.

Reputable History Full of Positive Cash Flows – two separate factors: earning history and reputation of your business can be combined into one, more powerful internal factor – a credible history of operations. First, and most importantly – corporate reputation. Your company’s reputation and goodwill within your community can be incredibly valuable. It can be relatively difficult to quantify an intangible asset like this, but nonetheless, it is vital to include this factor as one of the key determinants of your company’s value.

Second, and yet as important is the history of your operations. To perform a valuation, it is vital to analyze how and why money was generated in the past. This insight will help identify which activities generate cash and which incur costs. For this analysis, financial data of the past couple of years is commonly used. Any discrepancies found in the statements, such as inconsistent net margin results, unusual variations on paydays or one-off incomes, must be accounted for and communicated to the investor. This will ensure that the counterparts are on the same page, increasing mutual trust and decreasing the chances of any unplanned events occurring during the latter stages of the sale process. Remember, any unplanned or undisclosed errors can plan a seed of doubt in the buyer’s mind and that will surely increase the risk premium of the deal.

External Factors

The next few factors are external in nature, meaning that they make up the market environment where your business operates. These factors can’t be controlled but can and should be anticipated.

Market environment – you should always keep in mind that companies are not islands. Their value naturally depends on external factors too. Take for example the stock market trades, in general terms, if the stock market trades at high multiples, your company will be worth more than if the stock market was at its low, even if your company isn’t public and doesn’t plan to be. This is because the stock market is an alternative to investment. Saying this, any changes in the market environment due to technological disruptions or recessions, inevitably affect the end value of the company too. These changes in the market environment are perfectly represented by Michael Porter as the five forces: entry of new players, buyers’ power in the negotiation, ability to negotiate with suppliers, a threat of substitute products, rivalry between current competitors. These forces act differently according to the corresponding industry niches; however, all these forces affect the profitability of each business in the sector, and hence their values. Ultimately the market environment sets the conditions for the future results of the company.

Regulation and Competitive Positioning – there are certain variables like mastering a geographic or product markets, which increases the value of the company and entices potential buyers to incorporate a premium into the final price. For example. being a regional leader in long-term car rental service poses a set of advantages – not only does the company look better in terms of balance sheets, but because of the high barriers to entry into the market, investors will be appealed by the idea of a smoother entry.

Although positioning is viewed as an external factor, it is to a certain extent up to any company to prove its competitive position as the market leader. Furthermore, companies can find their share price affected by regulatory changes or if a new marketplace entrant disrupts the present competitive landscape. A good example would be a company that relies on low-wage labor that can find its stock price lowered if investors believe labor costs will rise with a pending minimum wage increase. Alternatively, in the context of a new entry in the marketplace, a smaller company can find its share price depreciate if a more established player enters the market or appreciate if a rival goes out of business.

After discussing the top 5 factors affecting the end-value of your business, it’s important to remark that this is not a complete list and there are numerous more factors, both internal and external, that must be accounted for to maximize the value of your business. If you would want to learn more about the valuation process or other topics on corporate finance, don’t hesitate to visit our blog full of insightful reads! If you are seeking professional advice regarding M&A, please follow this contact link. We are an international team with over ten years of experience in the field of mergers and acquisitions.


References

– Momoh, O. (2018). Business Valuation. Retrieved from https://www.investopedia.com/terms/b/business-valuation.asp

– Trembly, B. (2018). 6 Key Factors that May Impact a Business Valuation. Retrieved from https://tremblylaw.com/6-key-factors-may-impact-business-valuation/

– Johnson, J. (2018). Top 5 Factors That Determine the Value of Your Business. Retrieved from http://www.btaplans.com/strategic-business-planning-blog/bid/362499/Top-5-Factors-That-Determine-the-Value-of-Your-Business

– Johnson, J. (2018). Top 5 Factors That Determine the Value of Your Business. Retrieved from http://www.btaplans.com/strategic-business-planning-blog/bid/362499/Top-5-Factors-That-Determine-the-Value-of-Your-Business

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