In business valuation, the analyst must analyze several factors that affect the value of a company. Those factors also motivate investors to make the difficult decision to invest in a company. They are called value-drivers. The analysis of those value-drivers (investors motivations) provide critical information to the valuation analyst that help him/her determine not only the valuation methods to be used but also the procedures and variables to be considered within each method. Value-drivers can be influenced by the type of industry of the subject company, the circumstance of a particular transaction, or the circumstances or motivations of a particular buyer or seller.
Buyers or sellers of small businesses or professional practices can be motivated to buy or sell for a variety of reasons including: (1) buying a job, (2) realizing certain non-financial benefits (e.g. involvement with something of personal interest), (3) realizing a desired rate of return on investment, (4) achieving a targeted market position (eliminate a competitor), (5) achieving critical mass (for savings, access to capital, or many other reasons) and (6) liquidating the business.
Elements That Influence Value-Drivers
Some elements that influence value-drivers include:
Included in the buyer/seller motivation is the size of the business. In general, the larger the business, the more it is viewed as an investment, with return on investment being a major value-driver. Conversely, the smaller the business, the more the personal motivations of buyers and sellers, such as “buying a job” drive value.
Persistence of Customer, Supplier, and Employee Base
The more persistent and predictable the customer, supplier, and employee base, the more the value is driven by the established income stream. This is especially true if the persistence and predictability are not tied to the professional capability, reputation, or personality of one or a few individuals.
Ease of Entry
In general, valuation of businesses in industries with low barriers to entry is mostly driven by their tangible assets. When barriers to entry increase, the value of these businesses is driven more by their intangibles assets and the importance of their income-producing abilities.
Licenses, Franchise Agreements, or Permits
The valuation analyst should understand the reasons for and the ability to transfer licenses, franchise agreements, or permits as part of a going concern or separately from the business. When they are an inseparable part of a going-concern, they may not be valued separately from the business. However, when they can be valued separately from the business or practice, it may be appropriate to value them separately. In family law, some states require a professional license to be valued separately from the practice regardless of how long its been established.
A competitive market increases the value of an established customer base and an established market share. Therefore, the income-generating capacity of the business becomes central to its valuation and to investors.
Achille Ekeu, MBA, CVA
The Washington Valuation Group (WVG)
Achille Ekeu is a Certified Valuation Analyst (CVA) member of the National Association of Certified Valuators and Analysts (NACVA) in the DC-MD Chapter. He provides valuation services for Estate and Gift Tax, Purchase, Sale of business, Debt Financing, Buy-Sell Agreements, and Litigation Support in Divorce/Shareholders disputes cases. He can be contacted by phone at 240-274-9570 or by email at firstname.lastname@example.org.