Overview of MethodologyEnterprise value measures the true worth or economic value of a business. More specifically, it is a measure of the actual takeover price that an investor would have to pay in order to acquire a particular firm. To calculate enterprise value, investors and buyers look 'under the hood’ of a business and analyze the operations or 'business engine’, typically as part of a due diligence process. However, how much (if any) of that value is transferable is determined largely by whether the business can dependably generate revenue and profit at or above its current rate, even without the current business owner(s) in charge.
Many middle market businesses have strong business engines which would provide continuing profitability to prospective buyers. What these businesses often lack though is the documentation or proof to appropriately communicate these indicators of strength to potential investors, buyers or other key stakeholders. In the absence of this proof, these outside parties interpret added risk to the business and this in turn widens the valuation gap.
CoreValue® has developed a leading framework and methodology to quantify transferable enterprise value in middle market businesses. It was based on the attributes of a well-run business irrespective of industry. This methodology provides actionable transparency into the operations of a private business. The focused framework guides and enables business owners to document areas of their business that are most important to buyers when assessing risk. All of this enables companies to improve value, communicate among owners, boards, management teams, and other stakeholders, and ultimately to successfully transfer to new owners.
Both academics and industry experts have vetted the framework and standards. The framework is built on 18 value drivers (nine market based and nine operations based) by which private companies can be measured to determine true enterprise value, appropriately communicate risk areas, and provide actionable items for value enhancement.
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Summary of 18 Value Drivers
Based on studies at MIT, the following are 18 value drivers that impact business value. Nine of these value drivers are market based (value drivers external to the business) and the other nine are operations based (internal to the business). This research provides a leading framework for increasing value and measuring operational excellence in middle market businesses.
MARKET BASED VALUE DRIVERS
- Growth - Your company can demonstrate quantifiable and historic growth greater than its competitors, and can substantiate growth projections greater than the industry rate. It is important to assess company growth, industry growth and your customer advantage.
- Large Market Potential - The market supports significant growth of the business. Indicators of this value driver include market size, niche clarity, competitive monitoring and future market growth.
- Dominant Market Share - Your company owns the highest percentage of the available market relative to its competitors. Can you measure where your company stands?
- Recurring Revenue - Your company can rely on a portion of future revenue from contractually committed customers. Analyze your customer contracts, customer mix and customer retention.
- Barriers to Entry - There are significant obstacles facing a new entrant into your company's market. Can you articulate your legal, market and capital barriers to entry?
- Differentiation - Your company has a product/service with unique characteristics that provide a competitive advantage. Proof of qualitative and financial differentiators should be assessed.
- Brand - Your company has a recognizable brandthat reinforces the business' presence in the marketplace and supports the company's objectives. Brand awareness, advantage and protections are important areas to explore.
- Margin Advantage - Your company enjoys gross and net margins greater than the industry norm. Can you provide a history and explanation of historical margin trends? Do you have processes in place to constantly improve margins?
- Customer Diversification - Your company has a well-diversified customer base. Do you have any customer concentration? What are you doing to continuously diversify your revenue?
OPERATIONS BASED VALUE DRIVERS
- Company Overview - An outsider can easily obtain a holistic understanding of your company including your company's performance, practices, culture, discipline and mission. Consider things like your company's web presence and if employee can succinctly communicate what the company does, why and how.
- Financial - All of your company's financial matters are in order and you follow best practices. How quickly can your company generate financial information? What operating reports does your company use to make decisions?
- Sales & Marketing - Your company can produce revenue in a proven and systematic way, ensuring the business is sustainable and not simply based on the efforts of individuals within the business today. This would be demonstrated through sales and marketing objectives, comprehensive market research, repeatable sales processes and regularly reviewed metrics.
- Operations - Your company has the ability to deliver on the sales promises made to the marketplace and to do it in a systematic and process-driven manner. What performance metrics help you measure this? How does your company compare to industry standards?
- Customer Satisfaction - Your company tracks and uses key measures to meet customer expectations at all levels. Achieving this value driver means your company establishes goals, develops a plan and continuously measuring customer satisfaction.
- Senior Management - Your company has a leadership team/individual in place to realize the company's vision and mission while helping the owner achieve his/her objectives. Are clear roles and responsibilities, succession and compensation plans communicated throughout your company?
- Human Resources - Your company has the ability to find, develop, and retain quality individuals that enables success in all aspects of your business. Do roles of each employee support your company's goals? Do your compensation and benefits follow best practices and motivate your workforce?
- Legal - You have all legal matters in order, documented, and your company follows best practices. Also, there are no claims for or against your company, or its employees, resulting in formal proceedings.
- Innovation - Your company understands that innovation is invaluable to creating an ongoing competitive advantage; it has a proven and systematic way to drive and capture innovation at all levels and encourages innovation in every area of the business.
Studies have shown that focusing on these 18 value drivers will make your company more saleable and will assist in attracting a higher valuation multiple. These drivers also establish the highest standard for building operational excellence in middle market businesses.