Using valuation as a management tool [case study]

Posted by James Price | JPAbusiness on 07-Sep-2016 05:00:00

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Most business owners only seek a business valuation after being prompted to do so by a significant ‘event’, for example family break-up, retirement, need for business restructuring, bank lending requirement, purchase offer and so on.

My experience indicates the opposite course would be better: valuation should be considered a management tool and be done before, and separate from, such business and emotive life events.

The following case study shows how an independent valuation, carried out early, would have made life a whole lot easier for one of my clients.

Instead this client found themselves in a credit squeeze with little understanding of the true value of their business to potential financiers and the drivers that really matter to external parties.

Setting the scene

My client operated a large private business in an industrial services sector. The business had been operating profitably for 20 years. Turnover was approaching $500 million and they had about $75 million in borrowings.

The industry they operated in was under stress which was impacting their contracts and the utilisation of their plant and equipment. This in turn meant their cash flow and working capital was strained.

While they were looking for more finance to maintain operations, their banker was getting jittery about their ability to service their current level of borrowings.

The client hadn’t defaulted on their finance at all, but the bank was nervous because it was seeing other businesses in the industry fail.

To operate effectively my client needed a solid backer who wasn’t going to be jittery while they were going through this difficult period.

What we did

I worked with the client to look at a range of options to improve their balance sheet and funding position.

We worked with the incumbent bank, plus we shared the business proposition and financials with a number of other banks, as well as private equity investors.

Every potential financier – whether they were a private equity investor, equipment funder or major trading bank – raised the following issues as being critical to their appetite to support my client:

  • Customer base and revenue was concentrated in a few key clients
  • Contracts didn’t extend for a long period into the future and contained various out-clauses for customers
  • Past performance showed the business was profitable but did not generate a lot of free cash, which raised questions around serviceability of loans
  • Succession plans and key management personnel were focused around a small family group
  • The ability to meet budgets and efficiently deliver management reports to identify the business’ current situation was found wanting
  • There was a lack of strict processes, systems and controls over working capital, cash flow, debtors and creditors
  • There was an ageing fleet of plant and equipment which wasn’t being replaced in a proactive manner.

Most of the above was news to my clients, in terms of how the finance market might perceive these issues.

If they had been aware of how these risk factors were impacting their business value before needing to seek new finance, they could have addressed them. Then, when the downturn occurred – as downturns inevitably do – they would have been much better placed to ensure their funding lines were secure and stable.

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The take-home message for me (and you)

Working with this client made me realise that if you don’t have a clear understanding of your business’ fair market value – even though you are not remotely thinking of selling or exiting – you are leaving yourself vulnerable should an unexpected circumstance occur in which the market values your business.

This case study emphasises the need to get your business valued early on and then update it periodically as circumstances change.

The core of the valuation can then be used as a management tool and ‘checklist’ for addressing the risks and issues associated with your business.

For a valuation to be an effective tool you would need:

  • An independent valuation
  • A valuer experienced in your market and industry
  • The scope of the valuation to be more than simply requesting an assessment of the business’ fair market value. The scope needs to cover the risks and issues that are critically impacting on your business’ value today, both in terms of adding to and detracting from that value.

Such a valuation would not be coloured by emotive life events and you could use it to keep on top of ‘risk factors’ before they impact your business’ value.

If you’re interested in exploring how a valuation could assist you to develop an effective management tool for your business, call our business advisory team on 02 6360 0360 for a free, no-obligation and confidential discussion to find out what is involved.

 

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JAMES PRICE | JPAbusinessJames Price has over 30 years' experience in providing strategic, commercial and financial advice to Australian and international business clients. James' blogs provide business advice for aspiring and current small to mid-sized business owners, operators and managers.

  

Topics: Business Value, Valuations, Case study

 
Disclaimer: The information contained in this blog is general in nature and should not be taken as personal, professional advice. Readers should make their own inquiries and obtain independent, professional advice before making any decisions, taking any action or relying on any information in this blog. 
 
 
 
 
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