On Value

For a prospective buyer, the value of a business is based on its potential to generate enough cash flows to enable the buyer to recuperate the original investment and realize a given rate of return. Of course, the business’ past performance will provide anecdotal evidence about the enterprise’s potential to generate the earnings necessary to meet the buyer’s objectives. But, the real risk for buyers is making sure that past performance can be repeated and surpassed in the future.

Having a business that is too dependent on its owner is certainly one of the main factors affecting its marketability. When a business is sold, the seller is already on exit mode, so the continuity of operations is always an issue for the buyer. Additionally, there are other factors that often have a negative impact on the potential marketability of a business, among them:

• An inexperienced management team
• High customer concentration (having just a few large customers)
• Poorly maintained financial records
• Poorly maintained assets
• Contingent liabilities
• The threat of litigation

In the end, the acid test for an owner who wants to find out how marketable the business really is, revolves around the answer to a simple question: Can I afford to leave the business for a couple of months without any significant deterioration in its performance?  The answer to this question not only can be quite revealing, but also can point out the imminent need for a change in his/her leadership strategy.

About Enrique Brito

Enrique Brito is a senior finance executive and a principal at Kaizen Consulting Group. He is a national instructor and lecturer on M&A, business valuation and negotiation topics. Learn more about him here and connect with him on Twitter.