I recently sat in a medical clinic waiting for a friend’s procedure to be completed when I came upon a New York Times article that stated it is our life expectancy, not just our age, that is increasingly figuring into calculations about whether certain medical screenings and treatments are appropriate.
The crux of the article was when deciding if preventive screenings and treatments are no longer advisable, it is important to consider more than the patient’s age. What if a 76-year-old patient plays tennis twice a week? Had parents who lived well into their 90s? Or...has heart disease? Is a smoker? Any or all such factors likely affect the patient’s life expectancy. The article states, “it doesn’t make sense to draw these lines by age.” There is just so much more to each person’s lifetime story than a single number (age).
Similarly, the value of a business cannot meaningfully be determined by focusing only on the financial results of the company—especially when some try to value a business focused on one figure on the income statement—EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). While financial performance is certainly important (just as age is ONE important factor in making healthcare decisions), there are numerous factors that we refer to as “qualitative” that have a significant impact on how a buyer looks at a company. These factors also impact the value of a business. Think of them as the “story behind the numbers.”
- 1. Depth of Management—how dependent is the business on the owner(s)? The key is to delegate and document business processes.
- 2. Quality of Management—what is the overall culture of the company? What depth of experience, education, strategic vision, and technical skills are represented by management?
- 3. Recurring revenues—are there ways to develop a subscription-style stream of revenues for the business, even if sales are project based?
- 4. Age and Condition of Tangible Assets—is the owner continuously re-investing in the maintenance and/or replacement of the company’s assets?
- 5. Diversification in Product Line—does the business offer just one product or sell into just one specific industry?
- 6. Regulatory Risk—are there increasing numbers of or unsettled issues surrounding environmental, licensing, financial or other regulatory requirements?
- 7. Legal Risk—is the company engaged in litigation or unsettled arbitration/mediation issues?
- 8. Competitive Position—what is the company’s current market share? Is it growing or shrinking? Are there barriers to entry that make it more difficult for new competitors to enter the marketplace?
- 9. Customer/Client Concentration—does any one of the company’s customers or clients generate 10% or more of the total annual sales? Or, do the top five customers generate 30% or more of the company’s total annual sales. If ‘yes’ is the answer to either of these questions, this represents increased risk to the business and decreases value.
- 10. Characteristics of the Company’s Supply Chain—are parts and/or products sourced internationally? Do vendor dependencies exist or are there alternative suppliers? Do contracts exist that protect the company’s relationships and pricing?
- 11. Technological Risk—is technology threatening to replace some or all of the services provided?
- 12. Marketing Savviness—is the company’s website current with a fresh look and ongoing additions being made? Too often the business owners fail to check out their own websites.
- 13. Condition of Facilities—whether the business has offices, a manufacturing plant, or a warehouse, look at them with a fresh eye. What is the condition of the building, the signage, the overall sense of organization?
- 14. Here’s one that might come as a surprise—did you know that having some debt actually increases the value of a company? Debt is a less expensive component of the company’s total capital structure (debt and equity). Too much debt is obviously not a good thing, but some debt is actually a good thing. Call us to discuss that one further!
If you are interested in more examples of how to improve any of these items, see our earlier blog.
Business owners are constantly working to improve their financial results by increasing sales or profits. It would be wise to also consider and improve upon these qualitative factors as they all play a role in obtaining a supportable conclusion of the value of a business. No different than making healthcare decisions as we age…focusing only on the numbers (our age or the company’s profits) alone is only part of what needs to be considered to make informed decisions.
If you would like to discuss a specific business situation please reach out to us through our Contact page or call us at 608-257-2757 and one of us would be happy to talk through your situation.