The Adventures of Lee The SME Owner - 29.
Chapter 29 - The “Before” Valuation
With the transition process now underway and Sam starting to find his feet as General Manager, John suggested that it was the perfect time to get the business valued. This wouldn’t be the only valuation Lee would go through during his five-year exit plan—there would be a before and after comparison, which would be crucial in understanding how much progress had been made.
At this point, apart from a few structural changes in leadership and the beginnings of a product mix shift, there hadn’t been any significant financial changes showing in the business’s performance. That made it an ideal time to capture the "before" picture. John reached out to business broking associates to conduct a Fair Market Valuation (FMV).
The FMV wouldn’t just be a number—it would provide a full snapshot of the business, taking into account more than just profit margins and revenue. It would give Lee a baseline to compare against when the final valuation was done, years down the road, once all the planned changes had taken effect.
The Information Required for a Fair Market Valuation
To conduct a thorough FMV, a variety of information was needed. This process involved more than just looking at the financials. It required a deep dive into the business, taking into account multiple factors that contributed to the overall value.
Here’s the key information that they would gather:
Financial Statements (Past and Present)
Profit and Loss (P&L) Statements: These give an overview of the business’s profitability over the past 3-5 years, showing trends in revenue, costs, and net profit.
Balance Sheet: This document outlines the assets, liabilities, and owner’s equity in the business, giving an idea of the company’s financial health.
Cash Flow Statements: Cash flow is crucial, as it shows how well the business manages its money, particularly in terms of generating operational cash flow.
Tax Returns: Providing tax returns helps verify the accuracy of the financial statements and gives the valuators a complete picture of the business’s financials.
Operational Information
Staff Structure: Details about the team’s size, skill levels, management, and any key employees who contribute significantly to the business’s operations.
Supplier and Customer Relationships: Information about the strength and stability of supplier contracts and customer loyalty is critical. A business with strong, long-term relationships is more valuable than one reliant on short-term or fickle connections.
Processes and Systems: The efficiency of the operational processes, any proprietary methods, or unique systems that provide a competitive advantage.
Product Mix and Sales Channels: A breakdown of what products are sold, which ones are the most profitable, and whether the business is overly dependent on a small number of products or clients.
Growth Potential
Market Trends and Position: An analysis of the market in which the business operates, including its position relative to competitors and the overall demand for its products and services.
Scalability: Can the business be scaled up easily? Are there clear opportunities for growth? Businesses with the ability to grow without significant additional investment are often valued higher.
Innovation: Are there plans for new product development, technological improvements, or entry into new markets?
Customer and Supplier Stability
Customer Base: Details on the diversity and loyalty of the customer base. A business with a large, loyal customer base is considered less risky and more valuable than one reliant on a few large customers.
Supplier Contracts: Information on supplier reliability, contract terms, and whether there are key dependencies on certain suppliers.
Legal Information
Contracts and Leases: This includes reviewing any long-term contracts with clients or suppliers, and any leases on property or equipment. Long-term, secure contracts can add significant value to the business.
Licenses and Certifications: Any industry-specific licenses, certifications, or permits the business holds that are crucial to its operations.
Intellectual Property and Brand
Brand Strength: What is the brand reputation in the market? How well-known and respected is the business?
Patents, Trademarks, or Proprietary Information: If the business holds any intellectual property, such as patents or trademarks, that can significantly increase the valuation.
Why It’s Not Just About the Numbers
While the financial statements are the backbone of the valuation process, there are many other factors that influence the final number. A Fair Market Valuation goes beyond just revenue and profit margins—it takes a holistic view of the business.
Here’s why:
Risk and Stability: A business might be making a lot of money now, but if it’s overly reliant on a few customers or a single product, it’s at risk. The valuators look for stability—how well can the business weather changes in the market, customer preferences, or competition?
Future Growth: The valuation isn’t just about what the business has done; it’s also about what it can do. If the business has strong potential for future growth—whether through new products, new markets, or scalability—it will be valued higher. This is where Lee’s exit plan and product mix changes come into play. The goal is to increase this aspect of the valuation over the next five years.
Management and Succession: A business that can run without the direct involvement of the owner is far more valuable. This is one of the key areas Lee and John are working on with Sam. A smooth leadership transition will ensure the business can maintain value even when Lee steps back, and this will be a critical factor in the final valuation.
Market Position and Brand: A company’s market position and brand reputation can have a huge impact on its value. If a business is known for high quality, innovation, or superior customer service, that can add to the valuation. This is why Courtney’s branding work with Lee was so important. The stronger the brand, the more attractive the business will be to potential buyers.
Customer and Supplier Relationships: Long-term contracts, loyal customers, and reliable suppliers all add to a business’s value. Stability in these relationships reduces risk for potential buyers, which translates into a higher valuation.
The Before and After Picture
This first valuation would provide Lee with a baseline—a snapshot of the business as it currently stood. The next time the valuation was done, the changes Lee and John had worked on would be reflected in the numbers, and the difference would give them a clear picture of the business’s growth and value creation over time.
“This isn’t the final number, Lee,” John had said, reassuringly. “It’s just the ‘before’ picture. What’s important is that we use it as a starting point to measure how far we’ve come in a few years. With the right plan in place, you’re going to see that number grow.”
And so, the Fair Market Valuation process began, a crucial step in Lee’s five-year exit strategy. It wasn’t just about knowing what the business was worth now—it was about understanding what needed to be done to make sure it was worth even more when the time came to step away for good.