There are several quantitative and qualitative items used by business appraisers when determining the enterprise value of a business.
There are obvious numerical inputs that are vital in the analysis to arrive at an overall conclusion, such as historical and forecast earnings and cash flows. However, there are certain qualitative inputs that are also significant in determining a company’s risk profile, including the strength and depth of the management team.
A company’s risk profile influences the market multiples and discount rate used in the appraisal, as well as the overall desirability of the business to a potential buyer or investor.
Factors business appraisers consider when determining the overall strength, depth, and effectiveness of management include:
- How many people hold key management positions? Is management concentrated in one or two individuals, or is the company “top heavy” with too many managers with overlapping duties? In theory, members of management should have strategically segregated duties to promote efficiencies in running the company.
- Does the company have the ability to attract and retain qualified management?
- Does management have an active risk management process? An effective management team will go beyond risk prevention to identify strategic risks and form a risk mitigation plan.
- Do the members of management have an active strategic or business planning process? In other words, does management have both short-term and long-term strategic goals? If not, there could be additional risk in the company if management cannot articulate a longer term strategic and financial plan for the company.
- Do members of management analyze key performance metrics regularly?
- Is management able to maintain and improve relationships with employees as well as with investors or stakeholders in the business? Further, do the employees, board of directors, and the stakeholders have faith the management team can perform and produce results?
- Can the management team clearly communicate the company’s vision and goals?
- Does the management team have significant experience in its industry and a track record of innovation and market leadership?
- Does the management team have a strategy that is adaptable to changing business conditions?
- Do members of management behave ethically?
While it may be difficult for an appraiser to ask these questions outright when conducting a due diligence meeting with key members of management, many answers become evident during the discussion and also through the type and quality of information provided for the appraisal.
For example, if management cannot provide internal financial statements or intelligently discuss key operating performance metrics, an appraiser will likely consider the business to be riskier than one with a management team that can provide quality information as well as a vetted strategic plan.
Original content written for the American City Business Journals (2017)
