Revenue Size Is Not a Formula for Business Value

Revenue Size Is Not a Formula for Business Value

By Kim Levin

June 29, 2010

The simple truth is that all business owners will exit their business. The timing will either be determined by you or for you. It is unfortunate, but statistics show thousands of businesses each year sell for a fraction of their market value because owners don’t understand the true value of the business. Others are transferred to family members only to fail soon thereafter. Many are sold at liquidation prices to satisfy estate taxes. Improper timing of the sale causes many entrepreneurs to receive less than maximum value. Worse yet, after a lifetime of work, the proceeds are not enough to sustain the owner’s retirement.

Many business owners are under the impression that because they have invested money and time into their venture, it is valuable and marketable. Nothing could be further from the truth. In fact, many owners have created perpetual full-time jobs, not sustainable, valuable and marketable enterprises. This problem exists in privately held companies of all sizes, from the small to the very large company. Contrary to the common belief, revenue size is not a formula for value.

Building business value is not necessarily the same thing as building bottom line. Let’s define value, recognizing that there are different kinds of value:

  • Value for estate purposes – Takes into consideration the fact that the company will lose its driving force and have less capital to grow the business
  • Value for stock ownership plans – Here we presume no change in running the company and no change in capital structure except, that which is necessary to service the new debt
  • Value for mergers-and-acquisitions (M&A) – Here there will be new dedication, resources and an infusion of, or access to, the funds necessary for growing the business

To build value one must look at a business from an M&A perspective because value is the price which a willing and informed buyer will pay to a willing and informed seller with neither party being under duress.

Avoid the Common Myths of Value

    Myth 1 – Value building is same as business building
    It may come as a surprise but building the market value of the business is quite different than simply growing sales or profits. Certainly the more sales and profits a business has, the higher the value, but there are some hidden traps that will fool the naive owner. Higher sales or even greater profits may not always mean larger value!

    Myth 2 – Value is constant
    Market values of companies are dynamic, constantly changing, forever adjusting to the internal activities of the business and the external factors of the market.

    Myth 3 – Value is obvious
    There are no formulas, no rules of thumb, and no simple multiples that can determine with certainty what price an individual business will obtain in the marketplace. There can be general averages that apply across a broad number of companies in an industry, but such averages are usually inaccurate and often inappropriate for individual companies.

Therefore, value building must concentrate on what motivates sophisticated and serious buyers to pay premiums when they acquire businesses. In short, a practical strategy is one that is focused, specifically customized and stresses what works in the M&A marketplace. How the process works is not always obvious to owners who have difficulty seeing their companies from the perspective of a buyer.

posted by Susan Jones