A business valuation requires digging into the details of the business, including industry trends, regulatory risks, geography, and demographic trends. Below are a few seldom-discussed risks to consider when assessing a business:
- Industry risks
This is a broad category, but I consider it the risk of transformational change within an industry. One prime example is beverage choice. Millennials and Gen Zers have adopted a sobriety mindset or shifted preferences towards craft NA options or hard seltzers. This has caused large brewers to adapt to these changing trends and diversify their offerings.
Gen Zers experienced COVID-related shutdowns during their youth and have adapted to online experiences. We see this in the rise of telemedicine and the rise of social commerce. 97% of Gen Zers do shop in-store on occasion, but their primary motivation is to get products immediately rather than see or engage with people.
- Regulatory risks
The COVID-19 pandemic accelerated many regulatory trends that began about 10 years ago. The federal minimum wage has been steadily increasing with states implementing their own policies. The gig economy has become a large part of society and many states (California especially) have weighed in on how these gig workers should be compensated. During the pandemic, states loosened restrictions on liquor sales. Restaurants were able to sell alcohol for off-premise consumption. Alcohol was able to be delivered in many areas as well. Many of these loosened policies then became adopted, affecting the status quo of the local business community.
- Geography
A small business isn’t largely impacted by the growth of its broader metropolitan area, but rather the local community. For example, a business in Tinley Park, IL is largely unaffected by the growth or decline of the city of Chicago. A business in Golden, CO is unaffected by population trends in downtown Denver. However, local road construction or re-zoning efforts in the local community will impact the business. Also, access to parking can be a big deal. If a business with limited parking is being marketed for sale, I wouldn’t expect to see much upside in revenue growth. If a customer cannot park in front of their liquor store or fitness center, they will simply find another one.
- Demographics
Data on per capita disposable income, education, and population trends in the micro-community can impact valuation. Selling a superior good or service in a low-income area, or an inferior good in a high-income area will be challenging.
Conclusion
These risks can be factored into a business valuation in several ways. One is to build these risks into the benefit stream (forecast). For example, if there is a large road construction project in front of the business for the next 18-24 months, an appraiser may approach the revenue forecast more conservatively. The alternative is building the risk into the company-specific premium. The premium is part of the overall discount rate used to calculate the present value of future cash flows. The premium is applied to cash flows for all periods. If the risk is not limited to a finite period, it may be more appropriate to build it into the premium rather than the benefit stream. In either case, the same risk mustn’t be applied twice (“double dipping”).
Valuation is all about 1) cash flow, and 2) the likelihood the cash flow will continue. The fewer risks to the business, the greater the value of the business.
AMP Business Valuations is a leading valuation firm specializing in small business M&A. AMP is based in Denver, CO. Contact AMP at info@ampbusinessvaluations.com or 720-708-2584.
