The Roles Revenues and Margins Play in Business Value Creation

The Roles Revenues and Margins Play in Business Value Creation
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If you’re considering an exit strategy for your company, whether next year or two decades from now, you want the highest return for the effort, passion, and money you’ve invested over the years.

But how do you do that? Growing business value over the long term requires a different approach than pursuing short-term sales goals. Should you be driving full steam ahead to impress potential buyers with high revenues, or is it better to nurture your earnings by honing operational efficiencies and focusing on high-margin products and customers?

In one sense, the answer to this puzzle is obvious: Companies sell for multiples of cash flow and earnings; five times earnings is typical, but the “standard” multiples vary by industry. So increasing these figures will naturally increase the value of your business. But there’s much more to business valuation than this simple equation. Martin O’Neill, principal, Corsum Consulting, and author of Building Business Value recommends viewing your business from the buyer’s perspective: as an investment with its own risks and rewards. By taking steps to minimize risk while maximizing potential reward for your buyer, you can command a premium for your company.

O’Neill and other experts have identified numerous factors or value drivers that can push the price of a business up or down. Score high for these factors, and you’ll command a premium price. Score low, and you may find yourself selling at a discount. Here’s a look at some of the most significant business value drivers:

  1. Steady cash flow. “The price of an acquisition boils down to what’s going to happen in the future,” O’Neill says. “A company might have strong earnings in the past, but it has to show it can maintain the momentum moving forward.” By focusing your growth strategy on ongoing or repeatable business, (e.g., maintenance contracts over individual sales), you can build in such sustainability.

  2. Growth potential. By the same token, buyers want to see clear avenues for growth, such as untapped markets or potential line extensions. Investing in growth at the short-term expense of profits can be a valuable strategy if that growth gives future owners access to greater potential sales.

  3. Sustainability. One of the most overlooked areas for entrepreneurs looking to sell is setting up the business to operate smoothly no matter who is in the driver’s seat. “Entrepreneurs don’t like processes,” O’Neill says. “They have a hero mentality. But to position your company for sale, you have to transition into process development that works when you’re not around.”

  4. Unique value. “Generally, what drives value with your customers drives value with buyers as well,” O’Neill says. That means building a defensible position with a high barrier to entry for competitors. What this entails depends on what business you’re in. The value of a generic drug manufacturer, for instance, may lie in its low-cost structure, speed to market, and strong relationships with retailers. A tech company’s value may lie entirely in its intellectual property, and might require a rapid build-out to capture significant market share and network effects before the technical advantage is lost.

  5. Diversification. As with any investment, a company with a diverse product line and a broad customer base offers lower risk than one with limited offerings and/or a few major customers. While your biggest customers and most popular products may be the most profitable, investing in diversification will mitigate risk for your potential buyer.

Finally, O’Neill strongly recommends being aware of your own investment timeline. If you’re pouring money into a new market, product line or marketing campaign, when will the investment start to pay off in earnings, and how sustainable will those gains be? “You want to look great up-front, but you somehow still have to pass the test in your financial statements.”

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