Getting Real

Part II

by John V. Handelsman

 

In part one, we established that business appraisals can be more than just a tool to discover current value. A valuation can inform strategy and facilitate value growth from the market’s perspective. We believe that value growth is the most important measurement of performance.

Now, let’s review how appraisals work and how Present Values elevates the process from mere value revelation to strategic transformation.

Quickly, let’s outline the three approaches that most valuations take. Typically, the most heavily-weighted method looks at discounted future cash flows from the business. Appraisers combine these results with (1) the market capitalization of similarly situated public companies, and (2) the value of recent mergers and acquisitions of similar businesses to arrive at an overall enterprise value.

While these approaches are tried and true—and in fact foundational to any good appraisal—our team looks for more. That’s why we customize the valuation to add strategic value.

We want to help you see your business, all of its revenue and risk components, through the eyes of the market. That involves asking a lot of different questions and pouring over the details that align or distinguish your business model from the competitors that have the highest valuations. You know, the great companies in your domain, not just the good ones.

We’re not looking for the obvious here. Rather, we’re searching for unique strengths or weaknesses that, when juxtaposed to market realities, might materially impact your cash flow multiple to value. Take a look at just five of the questions that drive us in this way.

To begin with, we need to know the quality of the business’s earnings.

Leading a small to midsize business means grinding out day after day to generate profits. When the Present Values team arrives, we take a step back to investigate the nature of your revenue streams:

  • Are revenues coming from one-off projects, are they based on purchase orders, or are they coming from within a recurring revenue model?  Are there material concentrations?
  • At what stage in the product life cycle are your products?
  • Are your customers generally healthy? Are they diverse with respect to industry, geography, and product application?
  • Has the company developed its relationship with customers across diverse geographies and economies?
  • How diverse are your marketing, sales, and business development channels and the related sources of business connection that drive revenue?

The answers to these kinds of questions center around two things:  the nature of the customer engagement and the diversity of income. They show us how stable and reliable the company’s earnings might be in the long run and how they might stand up in an economic downturn.

In the words of ValueScope’s Chris Lucas, “Sadly, this kind of insight gets lost when leaders bury themselves in everyday sales and operations.”

Next, we investigate how much risk the market perceives in the company’s business model, particularly its labor pool, capital structure and supply chain. 

Has the company placed itself in a position to keep growing? Sometimes, good earnings can mask real and pending risk. We want to know if the company has inadvertently placed its resources in danger, and of course, that starts with its people. The appraisers we guide will gauge the company’s ability to attract and retain the human beings who are the true wealth of the organization:

  • Are there crucial roles in the business that are difficult to find, attract, train, develop, and retain?
  • Is the work environment inspiring them to grow? If the employment package isn’t strategic, they could leave—and the company’s capacity to deliver its secret sauce might disappear overnight.
  • Is there intellectual property and is it properly protected in all markets?
  • Is the business over or undercapitalized?
  • Does its equity or debt structure present critical timelines that don’t match up well with portfolio cycles or non-negotiable, customer or market-driven realities?
  • Is there diversity in the supplier base for critical materials and services?  Are the suppliers healthy?

So far, we’ve taken the market’s perspective of the company’s internal situation, but we’re not quite finished until we turn the lens outward. 

Our team asks those performing the valuation to tell us what’s changing within similar companies. Success can be dangerous. It’s easy to get caught with your head down and when you look up, discover that the competition and the market looks different. Suddenly, the game has changed. It isn’t enough to know what the movers and shakers in the industry are doing right now. We need to know what they plan on doing next. Looking to the competition doesn’t make you weak:  It makes you alert. Has the company conducted any real competitive intelligence?

At Present Values, we see valuation as a process of discovery, checking the vitals of the business and determining its capacity to adapt and thrive strategically within its environment. Valuation should be a component of the overall situational analysis and help to expose and define gaps in your business model when compared to those receiving the highest market multiples. With that information, we can help you develop strategies to close those gaps—strategies that improve earnings quality, lower risk, and point to maximum value.

Let’s be clear:  Seeing your business with transparency and precision is just the beginning. The real progress comes when leaders choose to act on the truth that is revealed. Truth today paves the way for growth forever!

Up next, we’ll share an example of a valuation done strategically that changed fundamental business strategy and provided efficient value growth, even when cash flow growth was only incremental.

 

John V. Handelsman is the founder and CEO at Present Values, LLC.  Present Values partners with companies to release and increase the value of their people, teams, and business overall.