Article written by:
Senior Financial Analyst
To state the obvious, businesses are complex. Some valuation-related complexities are vital to consider – a valuator will assess a company’s financial statements and projections, products and services offered, key management, ownership interest being valued, etc. In addition to these factors, there are other more ambiguous issues to consider. The factors discussed below may affect the value of your business:
- Company-Specific Risks: Aside from normal business risks, such as the risk of an economic recession, there are company-specific risks that can affect value. These risks are called non-systematic risks and can include key customer risk (if the business is dependent on a few major customers), key supplier risk, reliance on an individual owner or manager, pending litigation, extraordinary debt burden, significant environmental claims, etc.
- Working Capital Management: In the valuation world, cash flow drives value. Cash that is tied up in current assets such as investments in accounts receivable or inventory cannot be distributed to shareholders and may result in the need for additional debt financing (which also impacts value).
- Upcoming Capital Purchases: Similar to working capital management, cash that will be needed for a large capital purchase (such as a building addition or a major piece of equipment) cannot be distributed to shareholders. It will be important for management to determine whether the rate of return for such an expenditure justifies its purchase.
- Other Classes of Equity: Stock options, warrants, phantom stock, and other equity-based incentive compensation dilute the value of a company’s common stock. Stock options can cause dilution even if they are currently out-of-the-money (a popular misconception).
- Shareholder Policies: In the valuation world, a discount for lack of marketability is typically applied to a non-controlling ownership interest. The existence of a buy-sell agreement (or another vehicle by which a shareholder can achieve liquidity) enhances a stock’s marketability and generally leads to a lower marketability discount. Similarly, a distribution policy that provides shareholders with a meaningful, consistent return on their investment also enhances a stock’s marketability.
- Existence of Potential Buyers: The existence of potential buyers of the subject company is beneficial to shareholders, particularly minority-interest shareholders. The availability of potential buyers, including strategic buyers and financial buyers (such as private equity), shortens the expected holding period for an investor and increases the likelihood of a liquidity event.
Many factors contribute to, or detract from, a company’s value. Of the factors discussed above, the top five can be influenced by the decisions of management and/or shareholders. Please contact us to discuss what hidden valuation factors may be affecting your business.