4 key value destroyers. How to unwittingly reduce the value of your business.

4 key business value destroyers - Crowe Horwath Ireland

At Crowe Horwath we have always been focussed on how to build lasting company value for our clients. In recent articles we focused on the three fundamentals of sustainable business growth and the eight key drivers to building value in a business – all ways to build long-term sustainable value into a business.

In this article we examine those aspects which do not add value and more importantly situations where value is lost or destroyed in a business. Some of these are unique to particular businesses but there are also some common themes that come up again and again.

These value killers, as we call them, can lead to late price adjustments by buyers or a cancellation altogether of a sale process.

Value killer #1 – Poor cashflow management

When a buyer looks at a business they look at the total investment needed in order to make the business function. They compare this total investment to the return they will make – the profit from trading – and assess if the business is a worthwhile prospect to invest in.

A key part of this total investment lies in working capital such as stock and debtors. The more money locked up the lower the return and thus the lower the price they are willing to pay.

Take the following as a simple example:

Company A:
EBITDA of €500k
A business value multiple of 5
Net working capital of €1m
Amount paid for shares = 5 * €500k – €1m = €1.5m

Also when a potential buyer looks at the growth prospects for a business they will be examining how much they must invest for each extra sale. This consists of the amount of investment tied up in working capital and the ongoing investment needed to grow the business. If this growth consumes a lot of investment, then it lowers the return generated from the incremental growth as a percent of the investment. This makes the business now doubly unattractive as extra cash is tied up in working capital as part of the purchase price and the business is expensive to grow.

To take example of Company A above:
If €1m is set aside to grow the business, and the anticipated sales from that are €5m rather than say €3m then this is a more valuable business to a buyer and that will be reflected in the sale price.

Contrast this with a business which manages its working capital more effectively. Economists consider investment in stock as a measurement of inefficiency. The less locked up the more cash in the bank and the less that is needed to grow the business. More cash in the bank means immediately a higher price and lower cost growth model typically means a higher multiple sale price for the business.

If Company A was able to reduce its working capital from €1m to €500k then the remaining €500k would be in the bank. This cash surplus would be retained by the business seller while at the same time making their company more attractive to buyers.

Lesson: Turn a double hit into a double plus by managing your working capital efficiently.

Value killer #2 – Being a hunter business

A hunter business is one that needs to find news sales and new customers every day. You may say that applies to every business but what we mean here are businesses that constantly need to find new ones in order to survive. Think building contractor or large equipment sales – these businesses have large lumpy sales that are typically non-recurring. Yes, they may develop a reputation and benefit from referrals, but this is not the same as a recurring loyal customer base.

Businesses that have a client base which pays by regular subscription can be highly valuable. Think Netflix – it is their high growth and a steady recurring revenue that is attractive to buyers, more than its profits. Conversely builders, even successful ones, rarely sell for much of a premium over asset value.

If you recognise that your business is more of a hunter business you should look to transform yourself over time. What service can you provide to your customers that will keep them coming back? Preventative maintenance is the usual one. There are companies that provide a very cost-effective fixed price maintenance service just so that they can get the opportunity to upsell when their maintenance staff are on site. This creates a whole new sales force using a captive client base.

Lesson: if you are a hunter business you may feed very well for a time but you will most likely have many days that you go hungry.

Value killer #3 – Over-reliance on a key customer, supplier or employee.

When the iPod was being developed the chief engineer of Apple reputedly earned more than CEO Steve Jobs. Also, remember how everyone was aghast when Michael O’Leary earned a bonus of €17m back in mid 90s. Why? This is a result of these companies being over dependent on key employees at that time. Clearly these businesses have moved on and these risks have been reduced or removed.

Similarly, many businesses have a key supplier or customer that underpins the business. This makes the business vulnerable and can lead to a buyer or competitor bypassing the current business and poaching this relationship.

Lesson: You may have to accept some over dependence at certain times in your business growth but you must actively work to eliminate it.

Value killer #4 – Over-dependence on the owner.

Do you take pride in being at the centre of your business and knowing what’s going on at all times? Do you keep close to important customers, negotiate all the supply agreements and employee contracts? If so then congratulations, you may have created a worthless business!

Richard Branson says it is his job to hire the best people and then get out of their way. “Make yourself redundant” he says. This may sound counter intuitive but from a business buyer’s perspective they will not want to buy a business in which all the key relationships are wrapped around the owner. When the owner is gone chances are the value has gone also.
The owner’s job is to build the management team and hold them accountable. Ensure they manage the business and generate a strong return. This leaves the owner time to work on improving and developing the business and not involved in the day-to-day operations.

Lesson: Free yourself from the day-to-day and employ a team that can manage and grow your business.

When we work with business owners we look at how we can help you avoid these common pitfalls that end up destroying business value. We help uncover and maximise the opportunities your business has to grow and build lasting value. Contact a member of our Business Value Builder team to find out how we can help you.