The Multiple applied to the Earnings of the business (a key driver of the valuation equation) is largely driven by the perceived risks to the future earnings of the business.

Risks take many forms, and may include things such as over-reliance on key individuals, suppliers or customers, ageing assets, evolving technologies or government policy, potential for loss of intellectual property or workforce, etc. Similarly the assessed valuation multiple is often heavily influenced by the businesses (or industry’s) ability to scale efficiently or tap into future growth opportunities.

Consequently, a professional valuer should consider a wide range of “Qualitative” factors on an independent and objective basis when considering how peer group multiples should be adjusted to reflect “business specific” risk and growth profile.

A professional valuer should seek to understand how the business and brand are positioned in the marketplace relative to competitors. The overall strength of  position influences the business’ ability to scale, generate premium margins or conversely, insight into the headwinds faced.

Key considerations include:

• What differentiates the business from its competitors in the eyes of the customer?
• What degree of influence does the brand have (digital and media presence, social media followers, channels, SEO ranking)?
• How is the brand perceived in the marketplace, customers reviews and industry reputation?
• Is brand messaging consistent across website and social channels?
• Is the brand proprietary, licenced and/or protected and therefore sustainable?

Many businesses are exposed to varying degrees of risk associated with reliance on key customers, suppliers and staff – all of which have potential to negatively impact future earnings.

A professional valuer should seek to understand the extent that the business if exposed to these risks as part of their determination of an appropriate multiple.

• • Customer dependence.  Businesses which rely on any one customer for a large portion of revenues are exposed to significant risk to earnings should this customer be lost. As a general rule of thumb, businesses generating more than 15% of revenues from a single source are exposed to concentration risk.
  • Supplier dependence. Some business models rely heavily on 3rd party providers of specialised product, technical services or platforms etc to generate revenues. Whether or not this key element can be easily replaced by an alternative supplier is good guide to the degree of exposure to supplier risk.
  • Employee dependence.  Excluding owners – is the business exposed to key man risk? What measures are in place to secure / incentivise key employees for the long term?

For many SME’s, arguably one of the greatest risks to future earnings of the business revolve around the business’ degree of reliance on its founding partners or current business owners.

A professional valuer and/or potential buyer of the business should seek to understand the likely impact to the business should the owner depart. Typically the departure of owners is seen as a perceived risk to future earnings, loss of staff/culture, client relationships or intellectual property.

Key considerations include:

• • How involved are the owners or founders?
  • If the founders /owners exited how would the business perform?
  • Does the business have a management layer (sales and customer relationships, procurement, scheduling, financial control / payroll, marketing, administration) or are some or all of these functions handled by the owner/s?

The ability for a business to operate and scale efficiently is influenced by the existing systems and processes. Further the risk associated with loss of intellectual property through departure of key individuals (including working owners) is mitigated through documentation of critical knowledge, systems and processes.

A professional valuer should seek to understand how the business responds to these challenges through knowledge centres, efficient use and documentation of systems and processes.

Key considerations include:

• • Does the business effectively manage operational information (Work in progress, inventory balances, fleet management, scheduling, etc)?
  • Does the business report and track KPI’s?
  • What is the degree of professionalism associated with financial reporting processes (bookkeeping, management reporting, financial statements, audit)?
  • Are current systems and procedures documented?
  • Does the business have existing governance and board reporting procedures and policies?

A critical element to any business valuation is the contrasting of the valuation subject to competitive businesses (peers) and the market within which it operates. A professional valuer should seek to understand the subject business’ key points of differentiation, target markets, competitiveness of service/product offering in relevant markets alongside of other factors that have potential to influence demand.

• • Degree of concentration. Is in the market/industry comprised of mostly smaller players / highly fragmented or is it dominated by significantly larger strategic players or some other mix?
  • How is the company positioned in the marketplace relative to competitors (scale, geography, service offering and pricing).
  • Does the business have sustainable competitive advantages that will enable it to maintain or improve its position in the future?  (e.g. holds proprietary Intellectual Property providing a protective moat against rival players).
  • What barriers to entry exist and how is the subject business protected from new market entrants?