The #1 Business Valuation "Detractor"
Much is written about “value drivers”; strong financials, recurring revenue, desirable industry, scalability, impressive customer list, intellectual property, etc. However, I think of value drivers as prerequisites to attracting buyers for lower-middle market companies ($5mil - $25mil revenues). But eliminating “value detractors” is frequently even more important because it helps minimize a buyer's risk. In my opinion, the top two value detractors are: 1) customer concentration and 2) owner dependence.
Customer concentration is just what it sounds like – a high percentage of business derived from a small number of customers. My technology service company had this issue and frankly it was unavoidable. We had developed a web conferencing software and services platform specifically for hosting webcasts, webinars and online meetings for the pharma industry. One or two pharma companies can throw a lot of business your way especially if they are using your platform to market products. We achieved some diversification by changing our sales commission structure to focus on new customer acquisition. But at the time we were acquired, our lead customer still represented 20% of our revenues. We were fortunate it was a risk our strategic buyer was willing to take.
But the #1 value detractor for lower-middle market companies is owner dependence. While a high customer concentration can negatively impact a valuation, owner dependence can be a real deal killer. And as the business owner, this is one issue you have the most direct control over. Speaking from personal experience I think the vast number of entrepreneurs are control freaks. It’s either part of our core personality or the fact that in the beginning with limited staff and capital, you had to do everything yourself. I remember one of my first meetings with our buyer, the questions kept coming - who managed the relationship with Merck, who managed the relationship with GSK, who managed the operations team, etc. etc.? If my answer was me, me, me they probably would have walked out the door.
Putting staff in key positions of authority helps develop your management team and improves your exit valuation. A workplace with growth and professional development opportunity attracts and retains talent and leads to innovation. Bottom line - a strong management team not only increases the value of your business but almost always makes it a more attractive acquisition target.
Too many private business owners don’t consider “valuation drivers and detractors” until they decide to sell, which of course is too late. This is a primary reason why a large percentage of business owners never achieve a valuation they find acceptable. A good interim test is to see how comfortable you feel while taking a three week vacation. Hopefully you are pleasantly surprised how well the business runs without you!
If you would like to discuss exit options specific to your business or obtain a complimentary valuation, please contact me at 610-600-1060 or [email protected].
Best wishes for a prosperous 2018!
