In our investment banking practice, most clients come to us wanting to know what their company might be worth if it were sold it to a third party buyer, a member of management or to the employees. As a result, clients want a clear idea of the value of their company and how it impacts their future financial security.

When we run into a value gap (a difference between what the business owner wants the business to be worth and what valuation models say his company is worth), we focus on the solution rather than the problem. That means instead of debating with clients about the assumptions we've made or the valuation approaches we used, we shift the focus to a discussion about what the business owner can do to close this gap. We call this our value enhancement analysis.

Several years ago I began incorporating a value enhancement analysis into my valuation process. Now after completing dozens of valuation assignments using this approach, clients often tell us that the value enhancement analysis was far more valuable than the valuation itself.

One client said, "Getting a valuation without the value enhancement analysis would be like getting a diagnosis from your doctor but no recommendations about treatment."

Value Factors

We use the Gordon Growth Model (basic corporate finance formula taught in business school) as a simple, but powerful way to illustrate to clients the impact that small changes can have on the value of a business.

The Gordon Growth Formula says that Value = I/(R-G)

I - Stands for income or the cash flow that creates the return on investment for a buyer. This is often a proxy for pre-tax income, EBITDA or seller's discretionary earnings.

R - Stands for rate of return that buyers seek on any investment. The rate of return is a function of the risk that buyers perceive the company to have. This is expressed as a percentage.

G - Stands for growth that is based on the realistic and supportable assumptions a buyer would make about a company's future growth. Buyer's typically look at historical performance to predict future performance, but smart buyers also want to see sales and marketing processes, management strength, and internal systems in place to support that growth. This is also expressed as a percentage.

We explain to business owners that improving any one of these three aspects of the company will have positive impact on the company's value. Improving two or more at the same time can result in substantial improvements. Improving all three is like hitting the ball out of the park.

While this is very basic introduction, our value enhancement process looks at 54 different things that a business owner can do to affect the I, R and G in the Gordon Growth Model and maximize the value of their business.