Advisor Series: Business values, the Pandemic and demographics

Originally published in the Business Examiner April 2022 Issue.

The market for Small to Medium-size privately held Enterprises (SMEs) has seen its share of volatility over the past decade, and the pandemic was no exception.

While the Value Index as reported by DealStats the leading private market database remains at an average of 4.4 times since inception of the index, we have seen a low of 3.4 and a high of 5.0 times just in the last two years, since the start of the pandemic in early 2020. In the most recent quarter (Q1 2022 Report) the index plummeted

from the high of 5.0x to 3.9x while the sharp correction is not unprecedented, in light of the prevailing economic headwinds faced by many developed nations, accelerating inflation, and falling consumer confidence currently there is a clear lack of support for deceleration of the value erosion in the private company marketplace.

For those businesses who survived or even thrived during the pandemic, the realities of the aging demographics are again taking center stage once again.

Succession planning - taking center stage once again

Many business owners in Canada are part of the baby-boom generation who are looking or will need to retire and harvest their business value to fund their retirement years. Survey after survey ranging from the Business Development Bank of Canada (The Coming Wave Study) to PricewaterhouseCoopers (Once in a lifetime) has been warning us for years of the impending transition/succession challenge where as many as 4 of 10 business owners in Canada are expected to exit their business within the next 5 years, translating to hundreds of thousands of businesses coming up for sale in the next decade.

As we know, when there is an abundance of supply prices tend to come down, this is not great news for a business owner who is looking to sell their business and hope to retire rich.

We believe those predictions will come to bear sooner than later. Some of the past macro-economic and financial shocks, including the most recent COVID-19 pandemic, have delayed those predictions both from a personal financial standpoint and the need to navigate the business through the economic storm to ensure its survival. It’s not a question of if, but rather when, and the one certainty for many business owners is that time is running out and they will need to leave their business one way or another. As a result, we see the “Value Gap” the difference between potential value and the realized value widening.

In light of the current economic environment, aging demographics, and economic storm clouds forming on the horizon, what is an SME business owner to do to ensure they can exit their business successfully, leave a lasting legacy and monetize the value created throughout their life’s work?

Becoming "Buyer Ready"

To minimize this potential value gap, business owners need to prepare well in advance, it will be more important than ever to be buyer-ready. They need to consider the business’ current value in the eyes of purchasers, identify the factors that drive value in their eyes, and identify strategies to enhance those factors with the aim to increase the value and attractiveness of the business.

Assessing where the business value is today through an independent business valuation is the first natural step, a valuation will not only provide owners with a realistic estimation of the current business value, but also identify the specific value drivers and the risk factors of the business to help owners focus on the areas that will have the greatest impact and ROI in terms of business value, and make the business more marketable to a potential buyer.

Top 10 List - Value Drivers

While each business is unique and the value drivers differ by industry, there are some common ones that are somewhat universal. We have put together a ‘Top 10 List’ that each business owner should start with:

1. Stable and Predictable Cash Flow

2. Reliable Financial Information

3. Customer Diversity

4. Strength of Management Team

5. Documented Business and Marketing Plan - Growth Potential

6. Operating Systems, Documented Processes, and Procedures

7. Condition of Facilities and Equipment

8. Goodwill (attributed to the business, not the owner)

9. Barriers to Entry – Sustainable competitive advantage

10. Product Diversity

In Summary

With 80-90% of business owner’s financial retirement assets locked in their businesses according to the BDC taking the time to plan, prepare and position a business for succession well in advance (min. 3-5yrs) will no doubt give owners a leg up on the competition now and in the future.

If you would like more information or details about any of the values drivers mentioned above feel free send us an email to info@malahatvaluationgroup.com

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What do we do:

Malahat Valuation Group specializes in business valuation and real estate appraisals to owners of privately-owned companies and their professional advisors.

Why it matters:

When business owners and their professional advisors need to sell, leverage or reorganize their assets, we answer the age-old, question of "what is it worth"?

Who cares:

We provide our clients and their advisors a peace-of-mind by providing professional valuations that stand up to scrutiny from lenders, the Courts, and the CRA.