Key Value Drivers

[Muriel Pelley]

Forthe vast majority of businesses, especially those that operate with multiple stakeholders, value is primarily estimated in relation to its shareholder value. But what metrics and factors play a part in increasing this? The answer? Value Drivers.

Increasing shareholder value is of course one of the primary objectives for any entrepreneur; yet figuring out how you can maximise the value of your business is the key to understanding value drivers as a whole. Let us explore a little deeper as to what value drivers are, as well as how entrepreneurs can better take advantage of them.

Looking through the lens of strategy and finance gives you a view of total company value. The challenge is understanding how that can be enhanced, and it is the job of CEOs and senior managers to garner this understanding.

Another factor to consider at this stage involves the board of a company. Having high-calibre, relevant individuals on your board of directors signals to investors and the marketplace that the prospects are potentially encouraging for this company.

If customers, for example, are well-established entities, the risk to revenue begins to be mitigated, because they are less likely to default on payment. Well-established entities are often more likely to have well-established revenues themselves, making your revenue stream less volatile in turn.

For most companies that are sub-10 million in value, this value is calculated based on earnings multiple. When looking at the operating profit pre- or post-tax and then applying a multiple, the number increases based on the size of the business.

If you can steer the business through those rocky first few years to a point where investors can see an increasingly stable performance, you are benefiting from higher earnings and also a higher multiple to get a good valuation.

Naturally, your tendency will be to get on with developing the product and making it the best-performing of its kind, being mindful of the cost of delivering that product and of its margins, and the competition. That is going to be your overall focus.

At this point, it is important to assess how you can strengthen the management team and whether the team you had early on are still the best set of people to lead it forward. At the end of the day, growth is going to depend on this team and the perception that investors have of the quality of the management.

You may need to upgrade this team as you scale; strengthen the board and bring in the right people at the right time according to business growth and needs. That does not have to be the focus on day 1 but you should be aware of it from day 1.

When looking at memorandums within businesses for sale, one of the things that are often highlighted is contracted revenue as a percentage of overall revenue. Investors analyse the split in terms of the customer base, ensuring you are not heavily dependent on one or two customers that make up 80% of your revenues. It begs the question: what happens if you lose those one or two customers?

In fact, when a finance professional looks at what value actually means, it translates to future cash flows from the business. You arrive at a value by trying to estimate the future cash flows that this business will be generating.

Being short of cash injections at that point brings your business under stress and you might find yourself unable to pay out for your obligations and employees at this time, which can significantly drain morale from the company.

A value driver is an activity or capability that adds worth to a product, service or brand. More specifically, a value driver refers to those activities or capabilities that add profitability, reduce risk, and promote growth in accordance with strategic goals. Such goals can include increasing shareholder value, competitive edge and customer appeal.

For example, the value drivers motivating a healthcare company to move certain business processes from on-premises to cloud-based systems would be different than those motivating a manufacturing company seeking to implement digital manufacturing technology and link different data silos and processes of the manufacturing lifecycle.

When action is required to realize a particular value driver -- for example, managing inventory turns or variables that affect working capital -- the value driver must be defined at an explicit and commensurate level where action can be taken towards its realization.

For example, a C-level executive has overarching insight and high-level responsibilities that are very different than that of a front-line manager, yet each can carry out important value-driving actions.

Monitoring value is something that should be done in any economic environment. Ideally, business owners and their management teams should begin monitoring the value of their business at least five to seven years before considering an exit.

Valuation is a prophecy of future business expectations. To accurately reflect those expectations, it is critically important for a business owner to identify and understand what drives value? What factors increase cash flows and reduce risk? There are, quite frankly, hundreds of value drivers, some of which are industry-specific. For brevity, we will focus on ten universal factors we consider essential to increasing cash flows and reducing risk, thereby enhancing overall company value.

Questions to ask: How is the company currently leveraged? How do bank covenant restrictions impact the business and its future plans? Do shareholders have to provide equity or personally guarantee loans? Is bringing in an outside investor and issuing preferred stock a viable option?

A solid and diversified customer base is essential for the ongoing viability of a business. When companies grow and prosper by catering only to their largest customers, dependency may increase to the point where too great a percentage of revenues are concentrated with too few customers; companies must manage the allocation of customer concentration to reduce the risk of losing a large source of revenues.

As production output increases, businesses typically achieve lower costs per unit. Whether through quantity discounts or spreading capacity costs over higher volumes, larger companies possess distinct advantages in certain operations and markets.

Questions to ask: How does the company compare in terms of liquidity, activity, profitability, and solvency measures? Are financial controls in place? Are the financials audited or reviewed by an outside CPA?

Questions to ask: What are the quality control procedures? How effective are production/service capabilities? How is the company managed? What is the depth and breadth of management? Are there any key person dependencies in terms of technical knowledge, production skills, or customer contacts? Is there a management succession plan? What rights do individual shareholders have?

Each business is impacted by economic trends and developments in the industry in which it operates. Management must understand how the industry is impacted by economic factors and how the industry is structured to minimize the impact of macro trends on the business.

Specialty companies frequently derive their strength from focusing in niche fields, but concentration may create risks from lack of diversification and overdependence on limited markets. Some specialty companies may find their largest customers adopt a policy to deal only with suppliers who offer a broad range of products, forcing them to either expand product offerings or sell out to a larger company. Increasing diversification reduces risk, which improves value.

Companies with fewer monetary resources often lack adequate research and development resources, finding it difficult to keep pace with technological changes in their markets. Such companies often face an inescapable need to incur large amounts of capital expenditures in the near future or allocate resources to a limited number of product development projects. This inevitably results in product or service obsolescence, adverse impact on future growth, and loss of market share. In the meantime, larger companies are in a better position to demonstrate technological expertise by developing products that address emerging customer needs, leading customers to choose the state-of-the-art products, despite the eventual availability of lower cost, lower performance technology.

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Value drivers are generic and specific at the same time. Meaning, they are generic enough so every customer that meets your ICS criteria should be able to resonate with them. But they should be specific enough so the impact statements are measurable and real.

I usually advise startups to think about what they want their brand to stand for, and then ask their customers if that is what they see their brand as. The delta between these two factors shows the work that needs to be done to build the brand with effective brand pillars. Value drivers derive perception and identity from the brand pillars, but translate these brand pillars into customer impact that is tied to the product or service being sold.

The first example is more specific to a target customer (again, can also be a target segment) while aligning to the value driver example we developed earlier. The second example is vague and very open-ended.

It matters if you want to intentionally work towards and sustain product-market fit. Having impactful value drivers and a relatable value proposition will ensure you are a painkiller for your target customer and not just a vitamin they can cut the budget on with the next economic downturn. When a customer understands the value you deliver for them without having to make the connection themselves every time, that customer will be a long-term customer with you. I have written a lot here in the context of B2B customers but the same principles apply in the B2C space as well. Strong value drivers and value propositions bridge the need you are solving for with the customers who identify with that need. That is how you develop and sustain product-market fit.

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