How is it possible that a web based technology company with no profit be worth millions more than a stable service or manufacturing business with several years of revenues and profits? The answer to this “unfairness” can be found in the fundamentals of business valuations. All business valuations attempt to put a dollar value on a company’s future business potential.
Startup entrepreneurs and well-established business owners should have a sophisticated appreciation of how investors and ultimately business buyers will size up their company’s potential. Sometimes these factors which can influence company valuations are referred to as “business fundamentals” or “investment fundamentals.”
There are positive fundamentals just as there are negative fundamentals. Some fundamentals apply to the specific company’s operations while other fundamentals apply to broader market conditions. Businesses with a long list of positive investment fundamentals tend to receive generous business valuations.
Here are six fundamentals that will influence the value of your business.
No. 1: Revenue predictability. How stable is your company’s revenue stream? Businesses that serve customers through multi-year contracts or can prove they generate “recurring revenues” are valued more highly than companies that have to fight for every customer year after year. Annuity customers have more value.
No. 2: Customer list. A company’s customer list says a lot about its value. Ideally, businesses want to have an impressive list of clients or customers who pay their bills on time and are profitable for you. Further, higher value businesses are not dependent on any single customer for more than 20% of annual revenues.
No. 3: High gross profit margin business. High gross profit margin businesses have greater flexibility to make business mistakes or cut costs during an economic downturn. A high gross profit margin software company is valued higher than traditionally lower gross profit margin businesses such as grocery retailing.
No. 4: Intellectual property advantage. Businesses that own trademarks, patents, trade secrets, and copyrights can rely on federal laws to protect their innovations from competitor misuse. More valuation credit is given to intellectual property that can generate extra revenues from licensing income for a company, or that truly blocks competitors from participating in a market.
No.5: Brand strength. A good brand is different than owning a trademark. Brands have reputations and, if managed well, can be a valuable business asset. Valuation experts measure brand value in several ways. One of the most influential factors is if a company can reasonably apply the brand name to products or services in other markets.
No. 6: Low debt load. If your company is capital intensive and requires a heavy debt load (and therefore a high debt to equity ratio), your value will be lower than a company that does not need significant debt.
If you would like to discuss how to increase the value of your business, please contact David Lingler at Cassady Schiller.