Article: How well do you understand your company’s value drivers?
DETERMINING THE VALUE OF YOUR COMPANY (PART 2)
Using this valuation method enables CFOs to conduct valuations internally, without third-party appraisers.
Value drivers are the distinct qualities that make any company unique. When aggregated, they paint a picture of a company that is as distinctive as a Picasso, a one-of-a-kind representation illuminating its strengths and weaknesses, health and prospects, and what differentiates it from its closest competitors.
Yet while most CFOs and other managers are familiar with value drivers, in our experience few have taken the time to systematically analyze which ones best apply to their own organization. And fewer still recognize the central role they can play in determining the value of the business. Hint: It’s not just about revenue and EBITDA.
In fact, two companies with nearly identical financial metrics may have radically different values, based on a range of other considerations. One has blue chip clients while another doesn’t. One has patented technology while another uses technology that is easily replicated. One has a low rate of client retention while another holds onto clients for years. These and other drivers can move a company’s value up or down.
Our QuickValue process, based on Reed’s decades of experience working closely with middle-market companies, enables busy executives to conduct valuations internally, without third-party appraisers. Just as important, it’s the only valuation method that gives value drivers their well-deserved starring role.
We have identified 45 value drivers that should be considered. They run the gamut from market share and pricing power to leadership and the quality of the customer base. Others include financial controls and capital requirements, vendor relationships and product lifecycle, to name a few.
Establishing your company’s value drivers
As CFO, you should lead a team in deciding the 8 to 12 value drivers from among the 45 that are most essential to your company. Valuation is in your area of expertise, and you have the authority to rally other supporting players from your company. Make sure the team includes three or four executives with diverse expertise and experience, who are able to look at the business from every angle: finance, sales, product development and competition.
Start by thinking about your industry and what makes it unique. Then, focus on how your company fits into the competitive landscape. You and your colleagues may disagree on certain points, perhaps vehemently, but spirited debate will only help ensure you come up with a solid and reliable list of drivers.
Determining your Value Driver Score
Once you’ve narrowed the list, rate each driver on a score of 0 to 10, with 10 being the best. Reality check: you must honestly assess the company’s strengths and weaknesses — unrealistically generous self-assessments will hurt rather than help by not giving you an accurate valuation or proper guidance on how to improve your value. As CFO, and the leader of this project, you must officiate to ensure that the ratings are accurate.
Even among your chosen value drivers, some will be more important to your business than others. QuickValue uses a scale that increases the value of “very important” or “critical” drivers by a factor of two or three.
Here’s a hypothetical example. A company that provides market research using patented technology, rates an 8 for “intellectual property.” Because this value driver is so critical, its score of 8 points is multiplied by 3 for a total score of 24 points of a possible 30. “Market trends,” another area where the team feels they have an advantage, warrants an 8, but it’s not in that select top group of drivers and so is not multiplied. In a couple of other areas, customer service and sales, the team knows they need to get better. “Customer experience” receives a score of 2 and “pricing power” only gets a 3.
All told, the company’s 10 value drivers yield a score of 93 out of 140 possible points, for a Value Driver Score of 66%. (A complete rundown of this process is available in chapter four of our book, ‘QuickValue.’) In the next article in our series, we’ll show you how this score becomes a key variable in determining a company’s value when used in conjunction with multiples.
Beyond its key role in determining value, this internal assessment will make every participant on the team a better and more knowledgeable executive, and empower the company to redirect its strategy and resources with an eye toward improving its Value Driver Score. This in turn helps create a more valuable company.
More about Reed Phillips and Charles Slack, and their book ‘QuickValue’
Connecticut, United States
|Reed Phillips III
New York, United States
CEO and Managing Partner
They are the co-authors of the book, ‘QuickValue: Discover Your Value and Empower Your Business in Three Easy Steps.’
View Reed’s conference talk on the virtues of valuation for owners of private companies:
More about this five-part series on ‘Determining the value of your company’
This is the second article in a five-part series written for CFO.com about how CFOs can lead an internal team in determining their company’s value. The other articles in the series are:
Part 1: Are you your company’s Chief Value Creation Officer?
Part 3: Finding the multiples that best express your company’s value
Part 4: Unlocking new value for your company
Part 5: Putting value at the center of your strategic planning
*originally posted on oaklins.com on 2 November 2022