Just over a year ago, the WHO declared COVID-19 a pandemic. Throughout 2020, we saw the havoc and disruption governmental and societal response to the pandemic placed on millions of people and economies. Small and medium businesses were thrust into crisis overnight. They faced countless issues such as unpredictable consumer behavior, the adoption and deployment of new safety protocols, adaption to remote work, and new employee management processes.
The interconnected nature of global business and the disruption of the supply chain led to a significant loss of revenue and enterprise value for many middle-market companies.
What Our Research Tells Us
When we conducted our research on the effects of the pandemic on middle-market businesses, we found that:
- 73% of middle-market companies experienced a short-term or long-term revenue decline.
- 60% of middle-market leaders saw the pandemic, and 2020 in particular, as a value-destroying event.
- 28% of middle-market leaders will continue to see the negative impact of the pandemic in 2021 and continued revenue loss. Only 13 percent will expect a highly negative effect on their enterprise value.
- 54% of middle-market leaders expected the pandemic to push back their transition plans by at least one to two years.
That said, our survey findings also revealed that organizations with formal value creation plans performed better than their peers. They were two times more likely to experience a positive impact on enterprise value in the last 12 months.
We also found that advisors influenced value protection plans and strategy significantly. Middle market businesses that retained new advisors were twice as likely to impact their enterprise value positively.
An interesting finding of our survey was the majority of business owners realized the importance of value creation. In 2021, value creation is now a high priority for 80 percent of business owners. Even business owners who had no formal plan stated they placed high importance upon value creation in the wake of the pandemic.
The Next Step for Business Owners
For many businesses, things are certainly not turning around overnight. Value creation consultants have a unique opportunity to help their clients recapture value destroyed in the last 12 months.
A formal value creation plan can help owners regrow earnings while reducing business-associated risks. As we move towards the third quarter of 2021, business owners should expect a second-half rally. Though 2021 may still seem like a transition year, there is a significant opportunity to recapture the value destroyed in 2020. As an advisor, the best place to start with your clients is to ensure they have a formal value creation plan.
A formal value creation plan includes:
Establishing a valuable baseline for your client’s business (Did the baseline value of the company move? Yes, it did.) Determining the baseline value of your client’s business, personal assets, and other investments is the first step of exit planning. The baseline value is needed to create the company, estate, tax, and individual financial plans.
The pandemic threw a curveball at businesses, which means that existing value capture and exit plans almost certainly need to be revised if they haven’t been already. A new, systematic plan and approach will help businesses identify the most pressing pain points or triggers and the best strategies and actions to tackle them.
Ensuring leadership has a deep understanding of what drives enterprise value. Creating and protecting enterprise value means tackling a diverse ecosystem of financial, economic, environmental, and societal factors. The pandemic highlighted the fragility of this ecosystem and the dynamics of factors within. The leadership team must carefully analyze the degree of these impacts and spin disruption favorably by refining and reinventing processes and plans, restructuring strategies, and reviewing and revising their operations processes.
A company’s market capitalization, short- and long-term debts, and balance sheet are thoroughly considered to determine enterprise value. Business leaders who want to create and grow enterprise value in the current ecosystem must fully understand the landscape, including the trade-offs, tensions, and various balancing acts present within it.
Identifying the value drivers in the business/business model. Owners need to identify and understand what drives value. What factors should be considered to increase cash flow and contain risks? Factors to consider include:
- Access to capital: How is the business leveraged currently? Do shareholders have to give a personal guarantee on loans?
- Customer base: Has the business’ customer base grown in recent years? What is the percentage of revenue contribution by the business’ top customers?
- Financial performance: How does your company compare with other companies regarding activity, profitability, and liquidity? What financial controls are in place, and have they been reviewed by an advisor?
- Human capital: How is the business managed? Are there any specific dependencies in terms of knowledge, technical skills, etc.?
- Market trends and environment: How is the business positioned in the market? How will the market for your client’s business change as the pandemic lifts? Will demand change significantly? What about the supply?
- Product and service offerings: What services or products does your client offer? Can those service or product offerings be affected by economic and industry trends and swings?
Ensuring that value and value creation are baked into strategic and annual plans and the planning process. As a valued advisor, your job is to help your clients ensure the greatest potential value for their businesses when it’s time to sell it. To do that, you need to develop a value creation plan that will guide the construction of a phased strategy to help your clients achieve those exit goals. The plan needs to bake value creation right in and drill multi-year goals down into annual targets and quarterly rocks. An effective plan doesn’t just sit on the shelf. It’s a living document that is broken down into weekly tasks and referenced almost daily. Get a demo of Value Scout to see how it can help you drive your clients’ exit plans.
Ensuring that specific growth initiatives correlate to value (not just revenue/costs). For most owners, their net worth consists of the value of their company, which makes preserving the value of the business-critical. As a result, growth initiatives can’t just focus on revenue and costs. They have to focus on increasing the value of the business by aligning personal, business, and financial goals.
Focusing on long-term, sustainable initiatives. Help your clients commit to longer-term initiatives that will create value over time, such as product innovation, talent development, and marketing and sales. Investments in long-term strategic plans will result in higher rates of revenue growth and value creation. Currently, you might be tempted to take measures that boost short-term results such as:
- Diversifying long-term investments to make up for current challenges,
- Cutting costs to such an extent that you end up harming your market position, and
- Making unprofitable choices to tackle the volatility between revenue and earnings.
Business owners who prioritize long-term initiatives must accept the responsibility of reorienting their company to achieve the end goal of value creation.
Prioritizing recurring revenue streams. Recurring revenue streams are broadly classified as:
- Consumables (e.g., tea)
- Subscription revenues (e.g., gym memberships, Netflix)
- Auto-renewals (e.g., insurance)
- Contract revenues (e.g., when the customer has a contract that easily extends)
When an owner decides to sell their company, they should strive to make future revenues as reliable as possible to reduce the perceived risk to the buyer. Recurring revenue streams are sure-shot ways of increasing the value of your business/company and attracting potential buyers.
A business that flourishes even in the absence of the owner has more chances of attracting buyers (inside and outside) and closing the deal.
Ensuring there is a process to routinely re-assess. When owners implement their value-based plans, their prime focus is on how and where to allocate resources, establish procedures that drive operational excellence, and weed out business/industry-specific risks. All the implemented value creation activities need to be reviewed periodically to ensure that the end objectives remain the same.
The process to periodically check inputs and assess progress gives owners a realistic overview of their business. It enables them to identify roadblocks and determine corrective action to restore forward progress.
While the data frequently say otherwise, it feels like we’re turning the corner on the COVID-19 pandemic, at least in the U.S. Looking ahead, the keys to growing enterprise value is to figure out what aspects of the business have changed, what remains constant, and what is undetermined.
For more insight on the impact of the pandemic on middle-market businesses and their advisor relationships, download our e-book, 2021: Recovering Value Lost and Charting a Path Forward.