What is Value Gap Analysis?

Value Gap Analysis is a critical step in order for you to get the best return when you sell your business. I’m sure you’ll agree that getting the best return when you sell your business is the aim of every entrepreneur or business owner. However, it is not simply a case of contacting a business broker and putting a price tag on your life’s work.

There are a number of steps you need to take in order to get the best return on your investment. 

Ideally, the process to sell your business should begin 2-3 years prior to you wanting to exit. Therefore, given that the target date could be some time away, you need to have in place a solid action plan of how you will get the best return when you eventually sell the business.  

A good place to start is to determine what the business is worth now and what the business could be worth in 2-3 years time, if you put in place a comprehensive plan to maximise value. 

Often, we find that there is a disconnect between what the business is currently worth based on a bank accredited valuation for example and what the owners expectations are. 

We recently completed a business valuation for Sandy who operates a chain of healthcare retail stores. Sandy wanted to sell her business in 3 years and retire. Sandy didn’t really know what her business was worth.

In her mind, a figure of $1.2 million sounded about right for 20 years worth of hard work. However, a bank accredited valuation determined the business was only worth $750,000, a shortfall of $500,000 which equated to another 40% in value that Sandy would have to build. 

As part of the valuation, we conducted a Value Gap Analysis that identified a future value of $1,050,000 for the business at the time of sale for Sandy to achieve her desired retirement lifestyle. Based on Sandy’s current profit growth rates, we calculated that it would take another 7 years to achieve this sale price.

This case study highlights not only the unrealistic expectations of some business owners as to the actual value of their businesses, but also the importance of strategies to improve value and profitability by completing the sensitivity analysis calculations.   

In Sandy’s case, her path to target improvement in value was weekly sales and we’ll come to more on that shortly.

So, let’s summarise Sandy’s situation:

• Sandy needed to determine an accurate business value, not a best guess
• Through using the Value Gap Analysis calculation, a growth in value was needed to ensure the desired retirement lifestyle was met 
• In order to achieve that growth in value, what needed to happen?

So, how did we resolve Sandy’s issues? This example, like any that fall into the ‘Sales Price Reality Check’ category, can be solved in 4 steps. 

Step 1: Establish the business valuation

This can be done using our ‘Business Capitalisation Rate Calculator’ (BCRC) which is a patented algorithm that Insight CA Limited subscribes to. 

Put simply, a business capitalisation rate is a valuation tool ideal for SME and ME owners to determine a multiple of profit that then becomes the asking price. It is a fully automated calculation that enables us to benchmark your profit, capitalisation rate and value to comparable businesses across ANZSIC industries.

How we arrived at the BCRC Business Value for Sandy’s business:

You will recall that Sandy’s sale price expectation was $1,250,000.
However, our BCRC Business Value for Sandy’s Business was $750,000

Step 2: The Value Gap Analysis

Once Sandy’s value was calculated, when completed the Value Gap Analysis to determine the business value.

You will recall also, that we calculated Sandy’s future business value at $1,050,000.

Therefore, the equation looks like this:

Current business value $750,000 (3x Profit of $0.25m)
Future business value needed $1,050,000 (3.5x Profit of $0.30m)
Future profit target p.a. $300,000
Growth in profit required p.a. $50,000

So, $50,000 is our magic number. Let’s address that figure in steps 3 and 4.

Next comes the Sensitivity Analysis 

Step 3. $50,000 in extra sales

By completing our valuation and profit sensitivity analysis calculations, we identified for Sandy that she would need an increase in annual sales of around $50,000. This increase would still maintain her current EBIT margin of 10% however. The extra profit would thereby achieve the value needed at the time of sale.

Step 4. The plan to get to the business sale point

It’s all very well determining the magic figure of an increase of $50,000 in annual profit as numbers on a spreadsheet, but you actually need a growth plan to achieve that figure.

Sales tactics needed to be employed. Sandy asked each of her four locations to deliver an additional $2,500 in sales per week. 

The answer was for Sandy to implement a simple, but effective sales incentive plan for her retail staff. The retail staff were asked to focus on growing sales of products with high profit margin and rewarding staff for achieving their targets. 

The incentive, on the right products, has really resonated with the retail staff and sales started  growing immediately along with profit.

The Outcome of our analysis

We are pleased to report that Sandy is following the plan we created for her from the Value Gap Analysis, and combined with monthly guidance from us through our Board of Advice programme she is on track to achieve her target sale price in a little over 18 months.

Want to know more?

If you are thinking about preparing your business for sale or handing it on through succession, then get in contact with us today via email to organise a free no obligation chat. Also, If you need an accountant in Auckland – feel free to reach out. We will listen and then formulate the best strategies to help you achieve your goals. Alternatively, click on the ‘Book A Call’ link now to get started.

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