In its most simplistic form, value is a function of risk and cash flows. Higher risk factors translate into lower enterprise value. Therefore, you are able to maximize value by reducing risk. This article will look at three critical risk factors that could have a significant effect on the value of your business.
- Key-Man Risk. In our experience, most entrepreneurial firms are dominated by the owner. The Strong Owner drives top line growth either through relationships or by creating/maintaining the technology behind revenues. In any event, revenues are largely the result of a one-man show. From the perspective of a buyer, this represents a high level of risk since the cash flows are driven by a single individual whose absence would most likely have a detrimental effect on revenues. It is not uncommon for valuation analysts to add a “Key-man” risk premium in their valuation calculations that can significantly reduce the value of an entity. Therefore, in order to reduce the key-man risk, customers need to view The Company and not the individual, as the deciding factor for deserving their business. Company branding versus individual branding will reduce risk and increase value. Most franchise operations have perfected this concept. This is not easily achieved in a professional service environment but can be accomplished with careful planning and tailored messaging.
- Quality of the Workforce. One of the most valuable assets of your Company isn’t even visible on your financial statements, your employees. A well-trained workforce, committed to the company and its vision, can be a valuable asset. A well-run company invests in its people, providing them with adequate training, a compensation package that rewards their efforts, and open communication about the company’s direction and their future. A strong management team is never satisfied with the status quo. Current operations are scrutinized and evaluated on a regular basis. Budgets and cash flow forecasts are prepared and evaluated against actual results. Proper internal controls are in place and monitored for effectiveness. Improvements to products and services are studied and evaluated.
- Processes and Improvements. In the technology age, information is vital. A company’s IT system, tracking information such as inventory levels and product costs, customer sales history, and financial performance, is a critical factor in managing your business. Often the investment in new technology pays for itself in a relatively short period of time. Capital expenditures for your facility and equipment are necessary to maintain efficiencies in your operations and stay competitive. Any business that doesn’t have a plan for replacing outdated equipment will find itself penalized by potential buyers. Keeping your infrastructure up to date also places your company in a position to handle future growth.
Conclusion
Maximizing the value of your business is an ongoing process that doesn’t happen overnight. A structured approach focuses on increasing cash flows and reducing risk. A pro-active approach to identifying external and internal risks to your operations keeps you one step ahead of your competition. Your actions now can pay big dividends when the time is right. Here is another article discussing risk factors. Factors That Can Affect Business Valuation | U.S. Bank (usbank.com) Remember, maximize value by reducing risk!
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