Key insights
- If a business sale is in your future, knowing how your business could be valued is crucial.
- Dig into your business’s key value drivers so you can make informed decisions to help strengthen your organization and attract potential buyers when the time comes.
- Maintaining a healthy financial status, having a clear vision, and strong leadership are essential for your long-term business success.
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Business value creation strategies may be more important today than ever as the economy takes its toll on many industries and a generation of owners considers selling to family members, employees, or outside buyers.
Review how companies are valued so you’re ready when it’s time to sell. Then explore actionable value creation strategies to help your organization build resilience and long-term value.
Three approaches to business valuation
Many owners think they know what their business is worth, but the value in the marketplace may be much different than the perceived value to the owner. A valuation professional can help you understand the value of your business and develop a plan based on sound footing.
Asset approach
The asset approach is used for businesses where the current returns available to shareholders do not adequately reflect the fair market value of the business in its entirety. In other words, the earnings generated by the company do not create enough business value over and above the net assets of the company. There is no "goodwill" or "blue sky" value in the business.
With this approach, the assets and liabilities on the balance sheet are adjusted to fair market value and the resulting equity reflects the estimated fair market value of the business.
You often see this approach used for holding companies and equipment-intensive construction companies, such as road builders and earth movers, that show losses or modest earnings in the last few years.
Market approach
The market approach looks at similar companies and comparable public and private transactions. The valuator looks for actual sales of similar companies — and may also look for comparable public companies — and uses multiples to determine a value.
How to value a construction company? Comparables can prove challenging.
In the construction industry, it can be difficult to find companies that are truly comparable.
Using public companies as indicators of value is generally only appropriate for very large construction companies because it’s difficult to find comparable public companies that can be relied on for valuing smaller construction companies. Private transactions often don't yield enough comparable transactions to be reliable.
Income approach
The income approach uses historical earnings or estimates of future cash flows and present value techniques to derive current value. The most significant items of consideration are the income stream selected and the discount rate.
Key value drivers that influence business valuation
Understanding what drives business value is essential for owners, executives, and financial leaders — especially during periods of uncertainty. Whether you're preparing for a transition, seeking investment, or simply aiming to strengthen your organization, you can identify and enhance the areas impacting your company’s value.
Earnings
Strong earnings and consistent cash flow can be indicative of a company’s financial health and are foundational to any business valuation. Buyers and investors look for:
- Clean, accurate financial statements
- Predictable revenue streams
- Healthy margins and growth potential
If you don’t have a recent history of positive cash flows, value may be limited to the net asset value. Of course, you can’t change the past, but prospective earnings are significantly more relevant than historical earnings.
All other things being equal, a company with lower future capital expenditure needs may be worth more than a similar company with higher future capital expenditures. Delaying investments in machinery and equipment can harm your company’s value, because future cash flows may be needed for capital investment rather than as a return to the investors.
Another important factor to consider is whether your earnings are from repeat customers, or if a significant percentage of the earnings are derived from new sources.
Management depth and succession planning
A business with a strong leadership team and a clear succession plan can be more attractive to buyers and more resilient during transitions. This is especially important for family-owned or founder-led businesses.
Review employment and noncompete agreements
Your company's key employees should have employment contracts and noncompete clauses, or separate agreements to help uphold value transfer. Noncompete agreements must be legally enforceable (laws vary from state to state), geographically limited and time limited. Both parties should give up rights and received a benefit from the agreement.
Without a noncompete agreement, a buyer may discount your company’s value to account for the inability to prevent a key employee or owner from taking away future revenue of the company.
Consider personal goodwill
If a company has a sole owner, or there is a small number of owners, and the services, knowledge and relationships of the owner(s) are vital to the success of the company, there may be personal goodwill to consider. This goodwill is owned by the individual or individuals, not the company, and cannot theoretically be transferred by the company to a buyer.
A word of caution: If an owner enters into an employment or noncompete agreement, doing so may eliminate an opportunity to treat the sale of personal goodwill as a personal asset, subject to capital gain rates, rather than ordinary rates.
Competitive advantage
A company’s ability to differentiate itself — through brand strength, customer loyalty, or proprietary offerings — can significantly increase its value. Understanding your top customer segments and tailoring your value proposition is key.
- Is your company known for a specific kind of construction — residential, commercial, government, institutional?
- Who are the major competitors?
- Why should a buyer choose your company and not the one down the street?
If a company has a strong geographic presence or is located where the economy is strong, it may be difficult for a competitor to penetrate, thereby increasing the value of the company.
Consider the case of specialization: A construction business valuation example
A construction company that specializes (for example, C-stores, hospitals, restaurants, franchises, or government facilities) can often complete projects faster and cheaper than a contractor who doesn't specialize in a niche area.
Specialization generally allows for a competitive advantage and higher margins. However, if the industry in which the contractor specializes is in a downturn, there is a greater risk of financial failure than with a non-niche contractor.
Other value creation strategies that can create a competitive advantage
As you try to ramp up the right capabilities to increase company value, envision new ways of working, new capabilities, and new technologies. There are a number of business valuation strategies that can help position your company for long-term growth and resilience:
- A written succession plan
- Cross-training at key levels of management
- Two-deep leadership in key areas
- A strong working capital position and creditworthiness
- Diversified revenue sources to reduce dependency on a single stream
- A risk assessment that identifies potential threats in a business continuity plan
- Streamlining operations to improve productivity
- Leveraging technology for process automation and scalable infrastructure
- Customers segmented by purchasing behavior and tailoring offerings to needs of high-value clients
- Data to model pricing strategies to enhance elasticity and improve profitability
- Dynamic models that forecast volume trends, account for market shifts and other factors
Accelerating value creation with financial performance metrics
Regardless of changes to tax policy, external market conditions, or the impact of tariffs, middle market companies can benefit when owners and CFOs prioritize how to create value for customers, employees, and shareholders — and set specific financial performance metrics to track progress.
To accelerate business value creation, link clearly defined strategic goals and objectives with key performance indicators (KPIs) and objectives and key results (OKRs).
Many organizations use historical metrics as KPIs. OKRs take the next step of translating financial metrics into developing specific initiatives to boost value creation. While KPIs are stable, OKRs are actionable and change as achieved on a monthly or quarterly basis.
For example, you may set and track an objective to increase revenue by 10% over the next year, with key results including launching new products and expanding into new markets.
Select targeted financial metrics following key steps
- Establish financial OKRs that represent measurable key results, stemming from clear business objectives
- Track progress to maintain accountability
- Collaborate with the management and executive team on adjustments and actions
- Work with key stakeholders across departments to help you execute these initiatives effectively
How CLA can help with business valuation
Armed with this knowledge, you can identify your key value drivers and put plans in place to position your company for long-term success and increase the value of the company in the eyes of the prospective buyer.
CLA’s valuation professionals work closely with our business transition professionals to help you determine an appropriate business valuation.