Businesses and investors can create value in challenging and uncertain conditions

Owning, running and/or investing in a business should ultimately result in increasing or enhancing the value of your business and investments. Your business or your significant shareholding in a business should yield market related returns and ultimately result in the creation of value in the short, medium and long-term.

However, economic conditions are bleak. Current economic data indicates that most sectors experienced slow and/or negative growth. This data also shows that demand for domestic goods and services are extremely weak.  In addition, ratings agencies, S&P Global Ratings and Fitch, downgraded our country’s foreign currency debt to junk status. Fitch also downgraded the local currency debt. These events will knock business and consumer confidence very hard. There are also fears that our economy is staring recession in the face. Consequently, these tough economic conditions does not augur well for businesses and small and medium enterprises (SMEs) in particular.

However, all is not doom and gloom. SME’s should be resilient and should see light at the end of the tunnel. New opportunities will arise from these conditions. Therefore, SME’s should be well prepared and take advantage of these new opportunities as well as existing opportunities. These opportunities should lead to the creation of value over time.

In order to lay the foundation to create value in the business, value drivers and issues affecting the creation of value in the business must be appropriately identified, implemented and firmly embedded in the business. The owners/management of SME’s should also allocate adequate resources to ensure these value drivers ultimately lead to the creation of value for all stakeholders in the business.

Typical value drivers include:

• the quality, depth and strength of the management team,
• the level of motivation and capabilities of staff,
• the strength of intellectual capital,
• the quality and growth trends of key services and products with its respective market shares,
• the effectiveness and excellence of operational processes,
• the quality and reputation of the business and brands,
• the relationship with customers,
• the technologies that are used in the business,
• the ability of the company to design and create new products and services, and produce and market such products and services speedily,
• the distribution network,
• the cash flow and profitability of the business.

Management must keep its eyes on the ball by constantly focusing on these value drivers. The value drivers must, therefore, be integrated into the management activities of the business. For example, the value drivers should always form part of the agenda items of management and executive meetings, the value drivers must be included in the detailed corporate plans.  Moreover, any of these value drivers must at least be included in the performance contracts of the junior and senior management teams and should carry a significant weight. This plan will force management and other staff to focus on these identified value drivers. Consequently, consistently focusing on and managing these value drivers would strengthen it, and business performance would be significantly improved and long-term value created.

In conclusion, businesses should take advantage of current business conditions by looking for new opportunities, revisiting its business models and fine-tuning its operations.

Management and owners must periodically assess and measure whether these value drivers created value in the business. Certain metrics, measures, methods and controls are used to determine whether value was created in the business.

Another way to determine whether value was created is to perform a valuation based on the discounted free cash flow method. This valuation method projects future free cash flows emanating from the business and investments, and discounts such cash flows to present values. The valuation report would highlight the financial value of the business and how such value was created.  If the valuation report indicates that little or no value was created, management should go back to the drawing board by revisiting these value drivers and/or strengthen it in order to improve the future value of the business.

Other uses of the valuation report

The valuation report can also be used to buy or sell a business, assist in the negotiation of the price of the business, determine the feasibility of a project, raise funding, bring on board a new investor, sell a portion of investments and for mergers and acquisitions.

The SA Revenue Services use it for taxation purposes i.e. capital gains tax, estate duty and donations tax. Private equity firms use it to make investments in businesses and to evaluate existing investments and exit such investments.

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