5 Qualitative Value Drivers In Business Valuations
For entrepreneurs, business valuations are an invaluable tool. Whether you are planning your exit strategy or looking to work with investors or lenders, business valuations can help you make more informed decisions.
Business valuations are an official appraisal that measures the value of your business and should be considered if you are contemplating:
A change in ownership
A succession plan
A merger or sale
Bringing on a new shareholder or partner
Raising investment capital
Establishing an employee stock ownership plan (ESOP)
When developing the value of a business, there are two generally accepted valuation approaches: (1) the market approach and (2) the income approach, both of which incorporate quantitative financial measures. But financial performance is only one piece of the puzzle. While important, quantitative factors like revenue growth, margins, and forecasts are part of a larger picture.
Qualitative value drivers such as management, consumer loyalty, and company culture also affect the ability to generate profit. Intangibles such as these help to paint the complete picture of your business and enhance business value, which can lead to a premium valuation.
As a business owner, you need to understand the key qualitative value drivers and provide supporting information to be able to maximize your business's valuation. The following five qualitative value drivers are important elements to keep in mind when approaching business valuation.
Strategic Vision and Plan
Your strategic vision tells the story of how your company plans to achieve success. A well-developed strategic plan will take stock of your business’ current situation, determine where you want your business to be in the future, and devise a methodical, realistic plan of how to get there.
Companies that lack strategic direction or have overly complicated business models will likely drive a lower value. An easy-to-understand, holistic overview of your company practices, culture and core values will give context to the valuation and humanize your business. Preparing a strategic vision document that includes your company’s mission, vision, objectives and goals will demonstrate a strong growth strategy and can help attract a higher valuation.
2. Human Capital
Company employees are the lifeblood of a successful business. From your senior leadership team to your HR department, human capital is a significant contributor to the overall productivity of your organization and thus will have a direct impact on your business valuation.
While human capital refers to the collective knowledge, skills, creativity, and experience your staff possess and apply to produce economic value, it also consists of how effectively your company uses its human capital — as measured by productivity, innovation, and turnover. This means that part of company value depends on employee recruitment — hiring the right people who contribute to quality, both internally and externally, can strengthen company culture, customer relations, and production.
Company culture prospers from the top down. Your senior leadership team likely consists of industry experts, who drive the overarching vision and mission, and their ability to strategize and perform needs to be added into the business valuation equation. If your business has a strong and committed workforce all committed to the company’s overarching purpose, you can command a premium value for your company.
3. Proprietary Business Processes
Proven processes and systemized business operations — manual or automated — that are easy to understand, organized and documented are a key qualitative value driver in valuations. Procedures like production processes, training programs, quality assurance and internal communications plans have the potential to mitigate risk and improve operational efficiencies which can have a direct impact on expenses and profits.
Chances are, your company has a method to the madness, and taking the time to formally establish and thoroughly document your standard systems and processes will not only streamline workflow today but increase your business valuation for the future.
Beyond business procedures, proprietary assets such as patents, databases, intellectual property, and software can increase business value if they are sold alongside the company. Often, in the business valuation, if your company has developed an application, tool or technology, these proprietary assets can be valued individually and proprietary innovation can be leveraged to increase your business valuation.
4. Brand Recognition
Brand recognition is an intangible asset that businesses don't own per se. One part marketing, one part value creation, brand recognition is the unique images and associations that your stakeholders attribute to your brand. Both positive and negative, brand recognition can impact revenue. Company reputation and brand awareness are an attractive aspect to the business valuation, even if they are hard to define. And while your company cannot own brand recognition, there is much you can do to control it.
By generating customer loyalty programs, creating high-quality products or services, clearly and effectively communicating your company's mission, vision, and values, and creating a positive work culture you can enhance brand value.
To demonstrate your company’s brand recognition and prove that it generates an economic benefit to your organization, take care to maintain records like market analysis reports, sales metrics that show the effectiveness of past efforts and understand and measure your company’s culture.
5. Social Impact
Social impact is increasingly recognized as a source of business value. While being traditionally associated with voluntary work and philanthropy, companies and investors alike are realizing the value of businesses with a purpose beyond profit that positively impacts environmental, social and governance (ESG) issues.
Recently, CEOs of big brands have named social impact as a success factor for annual business performance. Even the CEO of BlackRock, Larry Fink, understands the importance of social impact, writing in his annual letter to CEOs: “A strong sense of purpose and a commitment to stakeholders helps a company connect more deeply to its customers and adjust to the changing demands of society. Ultimately, purpose is the engine of long-term profitability.”
Adopting industry-relevant ESG strategies can boost higher valuation multiples and margins for your business. Consider the following three social impact areas that can positively affect the valuation of your business:
Differentiation of the brand: Social purpose makes up a large part of a company’s reputation and can be used to your brand’s benefit as a differentiating factor. Social impact has the power to drive consumer purchasing decisions and enable companies to charge a premium, leading to increased revenue. A recent Nielsen study found that 66 percent of global consumers are willing to pay more for sustainable brands that align with their values.
Attraction and retention of talent: Workers across all generations are increasingly seeking opportunities to pursue social impact work in the corporate sector. Attracting and retaining human capital is important to business performance and aligning your company with social values can increase productivity, boost employee engagement, lower turnover rates and more. It has even been found that businesses on the “Fortune 100 Best Companies to Work for” list generated about 3.8% to 2.3% higher annual stock returns over a 25-year period than their competitors.
Operational efficiency: Executing social impact and ESG initiatives such as lowering your company’s carbon footprint through decreasing material waste, water usage and energy consumption can affect operating profits by 60 percent.
Value creation comes in many forms and often it encompasses more than just your business’ revenue. To better understand your company’s potential and strategize for the future. Be sure to consider the intangible value drivers as well as the quantitative ones to enhance the perceived value of your business leading to a higher valuation.