Owners tend to think about enterprise value as a number. The market thinks about it as a multiple applied to earnings, or occasionally to revenue. Both views are correct, and both are incomplete. Enterprise value, in the businesses we spend time in, is the sum of a small number of concrete assets, most of them not on the balance sheet.
What follows is the working framework we use with owners in the years before an event. It is not a list of things to do. It is a list of places to look.
Value accumulates in five places.
Almost every dollar of durable enterprise value in a founder-led business can be traced to one of five sources. The proportions differ by industry, but the sources are consistent.
1. Customer preference that survives price.
Customers who stay when the price goes up are the single most valuable asset in the business. They are usually not on the report. They are visible only when the price is tested, or when a competitor arrives with a lower one. Owners who have never raised prices tend to underestimate the strength, or the weakness, of what they have built.
2. A management layer that can run the business without the founder in the room.
We have written elsewhere about the cost of founder concentration. The other side of that ledger is the value of an institutionally-led management team. A business that continues to grow, decide and execute during a founder's two-week absence is worth a materially different multiple than one that does not.
3. Operating margin that is structural, not seasonal.
Every business has good months. The value question is what the margin structure looks like in an average year, on average terms, with an average team. Businesses whose margins depend on the founder's willingness to underprice their own time are worth less than they appear.
4. A repeatable growth engine.
Growth from a small number of large accidents is worth less than growth from a repeatable motion - a sales system, a channel, a product cadence, a category expansion process. The market pays for predictability far more than for absolute size.
5. Optionality that has been earned.
The right to enter an adjacent product, geography or channel - earned by existing customer trust or infrastructure - is worth real money at the multiple. Optionality that is only theoretical is worth almost nothing.
"Enterprise value is the sum of what a serious buyer would still be willing to pay for on a bad Tuesday."
"Enterprise value is the sum of what a serious buyer would still be willing to pay for on a bad Tuesday."
Where value quietly leaks.
In parallel with the places value accumulates, there are places it drains, usually quietly, usually for years before anyone notices. The pattern is consistent enough to be worth naming.
Customer concentration that was never diversified.
The first three customers who built the business become the three customers who cap the multiple. Owners resist the diversification because the concentrated customers are, by definition, the ones who love them. The market discounts the risk anyway.
Founder-priced labour.
When the founder is working ninety hours a week for a fraction of a market wage, the margin looks better than it is. Any buyer will re-price that labour on day one. Better to re-price it on the owner's own timeline, three years earlier.
Undocumented process.
A business that runs on institutional memory rather than institutional process is a business whose value walks out the door in the evening. Documentation is unglamorous work. It is also, dollar for dollar, some of the most valuable work an owner can commission.
Deferred capital expenditure.
Equipment past its useful life, systems that have not been upgraded in a decade, and technology debt that everyone talks around - each of these will be priced by a buyer, and each will be priced conservatively. Better to invest ahead of the event than to be diligenced through it.
A framework, not a checklist.
The framework above is not a to-do list. It is a lens. The question to ask, every quarter, is which of the five sources of value is growing, which is flat, and which is quietly deteriorating. And which of the four leaks is being addressed, which is being deferred, and which is being pretended does not exist.
The owners who arrive at an event with a strong number have almost always been running that quarterly review for years. The owners who arrive surprised by their valuation have almost always been running the business month to month, on operating metrics, without ever stepping back to look at the enterprise as an asset.
"The best time to start building enterprise value is roughly a decade before you plan to realise it. The second-best time is now."
"The best time to start building enterprise value is roughly a decade before you plan to realise it. The second-best time is now."
A closing note on time.
Enterprise value is compounding. The interventions that matter - building the management layer, diversifying customers, documenting process, re-pricing founder labour - all take between eighteen months and three years to show up in a diligence result. Owners who begin the work eighteen months before an event will see almost none of it in their outcome. Owners who begin five years before will see most of it.
The window is not closed. It is simply longer than most owners assume.
David Erickson is Managing Partner of IMRSV Growth Partners. david@imrsv-gp.com.