Your business is probably your most valuable asset, so it’s important to properly understand its value. Whether you realize it or not, the value of your business will have a big impact on both the personal and the professional aspects of your life. When you know what your business is worth, you have a more realistic perspective from which to plan for the future direction of the business, as well as the future income needs of you and your family.
According to the 2022 MassMutual Business Owner Perspectives Study, knowing what the business is worth is very much top of mind, with 61 percent of business owners saying that knowing their valuation is important, and 52 percent saying that they’ve had a valuation done in the last three years. But it’s not just the current value business owners are interested in knowing — it’s the potential future value that is piquing their interest as well.
Future value is just as important as current value
Our research indicates that even though 77 percent of business owners received a current valuation that met or exceeded their expectations, 49 percent are interested in knowing their potential future value, and 48 percent believe their business value will grow in the future.
The top reasons for wanting a future valuation are to:
- Assess the business’s growth potential.
- Estimate any estate tax obligations.
- Know if there is sufficient value in the business to fund retirement.
- Know how much value could be left on the table at exit.
These reasons are different from the reasons business owners give for wanting to obtain a current valuation. Those reasons tend to focus more on monitoring the health of the business and knowing what they could sell it for. According to our research, it appears that business owners are using their future valuation as the foundation upon which to build their succession, retirement, and estate plans.
Enterprise value is the key to understanding future value
To gain insight into the potential future value of a business, owners should understand their “enterprise value,” which is based on combining three distinct measures: business operations, financial results, and market data (or how similar businesses have sold in the marketplace).
With enterprise value, business owners can identify strengths and spot operational weaknesses in the business by looking at specific “value drivers.” Think of these as the different levers you can pull to improve the inner workings — and thus the value — of the business. Some of the drivers are in the direct control of the owner, such as their recurring revenue models, sales and marketing, and human resources. While others are market driven, such as barriers to entry, market size, and the competitive landscape.
The resulting figure is a measurement of the business’s ability to generate future revenue and profit. And, of those business owners who believe their values will grow in the future, 57 percent say it will come by strategically improving the operations inside the business versus an acquisition or a merger.
Ways to enhance your future value
Oftentimes, there is a gap between what the business is worth today and what it could be worth if it were viewed as best in class in a given industry. That gap is the value the owner could be leaving on the table at exit if there are deficiencies inside the business. If you are looking to enhance your future value, here are five areas you may want to focus on first:
- Ensure that your sales and marketing process is well-run, well-documented, measurable, and implemented by a team of people. If one person is driving the company’s sales, it’s not a process; and if it’s run by the owner, it’s not scalable.
- Be sure a large percentage of revenue comes from repeat business. Potential acquirers look for consistent, recurring revenue from multiple customers. Dependence on one core customer for the majority of revenue is viewed as too risky.
- Rely on systematized, process-driven operations to get the job done on time, every time. Be sure the business delivers on its promises to the marketplace and everything is documented so that anyone taking over can learn and understand how your business is run.
- Develop products and services that are distinctive and well-differentiated from your competitors. Selling commodities — products and services that are easily copied or purchased from other companies — doesn’t drive value.
- Focus on building a strong management team that understands the business inside and out and makes the owner as redundant in the business as possible. Also, have benefits in place to ensure that these key employees stay loyal to the business through any transition and beyond.
Knowing versus understanding your business value
Knowing the value of your business is simply having a number. Understanding your value is having a number and insight into what’s driving that number so you can take action and ownership of it. (Business valuation calculator)
When business owners focus on understanding what drives value in their business, and how they can impact and influence their enterprise value, they better position themselves and the business for future growth and financial success.
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