The main reason for buying a business is to get a streamlining of profit. One of the key questions a buyer should ask before deciding is “how much money can this business make?” While the answer is not absolute, there are value drivers one should examine to determine the value of the business.
Knowing these value drivers are important as they dictate what’s not on the page. More often than not, financial reports are unreliable. Incomplete and inaccurate taxes are intended to minimise the owner’s taxes, not to tell you how the business is doing. Going the extra mile of preliminary due diligence is important to cover all bases.
Here are some business value drivers that buyers should know:
Recognise its Growth Potential
Assuming that you’re buying a business due to its recorded success, the last thing you want is to plateau, or let alone crash. Recognising a business’s potential is an intangible business value driver that relies on your sense of discernment and plans. 30% of your focus should be on what the owner has done, and 70% on what you can do. Take the building blocks that are provided and use that to jumpstart the nitty-gritty of the things that can be done under your ownership.
Another factor that can help you scale its growth potential is its market position. The positioning of a business from its competitors is a strong indicator of whether it will thrive or fail. If you’re buying a retail store in a shopping mall where direct competition is strong, the multiple will be reduced. Examine what differentiates your products and services within the marketplace and use that as an investment to attract more consumers.
The Longevity of the Business
A business that withstood the test of time is a testament to a steady gross sale, which supports a strong sales drive value. In fact, it’s a challenge for most businesses to even make it to year 2. If the business that you’re eyeing has been operating within the 3 to 5-year range, it’s an indication that the owner has reaped what was invested.
Customer Concentration
Is your business’s profit concentrated on a few large customers? If so, losing a customer that brings in a huge sum of your revenue can lead to devastating losses. Before buying a business, carefully scrutinise its customer base. This will give you a snapshot of the business’s overall value. Ideally, a business’s revenue should be evenly distributed to a wide network of customers – not just one. If 10% of the business’s overall revenue is coming from a single customer, the business is at a major risk.
Buy a Business that You Desire
Ultimately, you are your own business driver. It all starts with your intentions of buying a business as it is equally emotional as it is financial. The passion for running a business generates goodwill; goodwill is a crucial factor to keep the operations running smoothly; smooth operations result in happy customers, and happy customers equate to cash flow. If your heart isn’t in it from the beginning, chances are it’ll just go downhill from there.
There are preliminary questions you can ask yourself to evaluate if this business is for you: Is this my niche? Do I have the necessary skills that this business needs? Will this business fit my lifestyle? Is this the size of business I can manage? Is this the location I want to be in? Will I be able to commit to the time needed to meet with suppliers? If most of your answers are affirmative to your wants, you’re on the right track.
Pay careful attention to these drivers to grasp a better understanding of the value of your business. The key is to go beyond the executive summary and business profile you’re given. Business value is something that you should dig deep for, and this will not help you manage your expectations, but will also help you shape the business model you should adopt.
