Skeletons in Your Closet that Block Value Creation

Virtually every business owner has a number–a monetary value they believe their business is worth or a value they want their business to be worth. Hence, they have a well-planned exit and retirement. Unfortunately, what the business owner believes often exceeds the business’ actual worth. Usually, such a business could certainly be worth more if only the key-value destroyers were absent. We call these destroyers of value the skeletons in your closet. These factors decrease your enterprise value.

Buyers or investors discount the value of your business if they find such hidden skeletons. As value creation is a part of exit planning, your advisors are responsible for helping you identify these value destroyers before a prospective buyer does and take corrective action to eliminate them.

Let’s discuss some of the skeletons that may be hidden in your business. They are the reasons why seemingly similar businesses get different valuations, and they show the difference between companies that are exit-ready and those that think they are.

You need the services of expert business valuation specialists who have the eye to identify your business value destroyers and the experience and skills to turn them around in your favor.

Related: Why Value Creation Initiatives Fail. 

Factors that Decrease Your Business Value

1. Unfavorable Market Conditions

Market conditions or the relationship between supply and demand can create or destroy value. Are the products and services you offer in demand, and is that demand growing? Or are they stagnant or declining? Do your services face significant downward price pressure due to a glut of new entrants? The answers will let you know the level of risk in your business.

2. Nature of Business

Does your business depend on fluctuating factors, such as seasonal conditions, which may cause demand to vary for reasons beyond management control, such as a snow removal service or ski resort? If so, this lack of control destroys your company’s value.

3. Customer Concentration Issues

Do you have an established loyal customer base? What is the level of customer concentration in your business? If your top four customers account for 60 to 70 percent of your revenue, you may feel comfortable with that; however, the buyer will certainly not because your loyal customers may leave with you. That’s a massive risk for the investor.

4. Heavy Dependence on the Business Owner

Lack of good management blocks value creation. If your business depends on your or a few key individuals, that places it in a high-risk category that decreases its value. To eliminate this risk, you need to have well-defined processes, roles, and responsibilities that other people can assume without loss of productivity or clientele.

We cannot stress too much the need for succession planning regarding this issue. If an investor cannot see a succession team capable of running the business smoothly after the owner and key individuals exit, it is not a good investment.

5. Lack of Documented Processes and Policies

Documented processes and policies facilitate an easy transition for the buyer. They ensure that the new management will soon run the company smoothly with little disruption after the deal. It also shows that the company is process-driven and not owner-driven. On the other hand, the opposite of this situation kills your business value.

6. Fluctuating Income

Volatility, i.e., fluctuating sales and profits, makes income challenging to forecast. That increases the buyer’s perceived risk and pushes your enterprise value down.

7. Inefficient Business Model

How does your business model work? How does it generate revenue, and is it recurring or one-time revenue? Businesses with recurring income attract higher valuations than those dependent on the continuous acquisition of new customers.

Further, what is the level of involvement of suppliers or partners? Despite being cost- or scale-effective, reliance upon a specific supplier or partner means a part of value creation depends on someone else.

8. Lack of Business Scalability

Value is determined by how scalable the business model is. For instance, traditional consultancy businesses are not scalable because their revenue is limited to the hours each consultant can bill. On the other hand, companies selling software, such as an ERP platform, can smoothly scale because they invest one time in software development, and costs do not increase with the number of subscribers. If you cannot find leverage in your business model and search for scalability, this skeleton in your closet can adversely impact your business value.

9. In-house Production

Depending on your business’ unique setup, this factor can increase or decrease enterprise value. If you have developed product development synergies, your margins are under control, you continuously engage in innovation and improvement activities, and your customers have developed a liking for your products. In-house production can increase your business value. If not, it is a value destroyer.

10. Poor Marketing and Branding

Do your marketing efforts reap the desired results? Does your sales team easily complete new client acquisitions? Does your brand attract loyal customers? Do you have a recurring customer base? If the answer to all these questions is no, then poor marketing and branding destroy your company’s value. You must turn this situation around to create value.

11. Condition of Your Investments and Working Capital

A buyer acquires your company’s debt along with the company. Debt reduces the company’s cash flow value. Are you managing your company lean, especially the working capital? Are your debt levels low? High working capital requirements accounting for increased debts will lower the company’s equity value.

Is your company adequately invested? Over-investment leads to increased debt which, in turn, negatively impacts the company’s equity value. However, under-investment will improve your short-term financial position but come out as a value destroyer in due diligence.

You need to identify these value destroyers and invest wisely in maintenance. Designate new investments towards quality and growth.

Concluding Thoughts

The above list of value destroyers is not exhaustive. Your business valuation advisors may identify many more skeletons in your closet that reduce your company’s value.

Exit planning is incomplete without a proper assessment of your current business situation. Depending on the current business value, advisors will strategize and create a program that could take years for your company to reach the desired value and become exit-ready.

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Matt Lawver

Matt Lawver

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