How can you determine the best steps to take to increase the value of your business?
The Return on Value Driver’s Model (RVD™ Model) is a proprietary tool developed by Morgan & Westfield that helps identify which aspects of your business to improve that will have the biggest impact on its value. The goal of the RVD™ Model is to help you increase the value of your business with the least amount of effort.
This article answers the following questions:
- How do I maximize the value of my business?
- What value drivers should I focus on first?
- What value driver will increase my business the most?
- How do I quickly maximize the value of my business before I sell it?
The RVD™ Model helps you prioritize which value drivers to focus on first based on the following criteria:
- Return. What is the potential impact, or return, of implementing the value driver on the value of the business?
- Risk. What is the risk associated with implementing the potential value driver?
- Time. How much time does the value driver take to implement?
- Investment. What financial investment is required to implement the value driver?
The RVD Model helps you determine those action steps that will have the greatest impact on the value of your business in the shortest period of time and which also pose the lowest risks to implement. In this article, we walk you through a step-by-step process for deciding which aspects of your business to focus on improving first. We also provide a sample RVD Model based on a real company. If you want to maximize the value of your business but are short on time, this article is for you.
Table of Contents
- Steps to Completing the RVD™ Model
- Sample RVD™ Model
- Commentary on the Sample Model
- Tips for Completing the RVD™ Model
Steps to Completing the RVD™ Model
Step 1: Rate each Value Driver on these Four Criteria — Return, Risk, Time, Investment
Step 1 involves rating each potential value driver based on the four factors of return, risk, time, and investment. The rating should not be considered definitive. Instead, the purpose of the rating is to allow you to loosely prioritize the potential actions you can take. This can help you focus first on the highest impact actions that are also the lowest in risk and require the least investment in terms of time and energy.
Step 2: Prioritize the Value Drivers Based on the Overall Rating
Step 2 involves prioritizing the value drivers based on their overall rating. Improving the value of your business should not be done in a haphazard fashion. Rather, you should prioritize the potential actions you can take and then execute one value driver at a time in a systematic fashion using a combination of Scrum (Agile) and weekly sprints. Most business owners take a hodge-podge approach to value maximization, as opposed to a strategic, intelligent, and rigorous approach. The objective of the RVD™ Model is to provide you with a strategic, structured approach to increasing the value of your business. It helps prioritize the actions you can take based on potential returns, the risk involved in achieving those returns, and the associated cost in terms of time and money.
Sample RVD™ Model
Below is a sample chart of potential value drivers for a middle-market technology company, along with the accompanying criteria (return, risk, time, investment) and a discussion of how each value driver was rated.
*The weightings below will vary significantly from company to company. For example, in a company with underperforming metrics, the potential return on improving metrics may be very high (e.g., 9 or 10), but in a company that already has favorable metrics, there may be a much lower potential return (e.g., 2 or 3).
|Return on Value Drivers: Acme Software|
|*Criteria are rated from 1 to 10. A higher rating is better — a 10 rating for risk means the action is lower risk and a 2.0 rating for risk means the action is higher risk. A 9.0 rating for investment indicates that a low investment is required, and a 2.0 rating indicates a high investment is required.|
|Document Comparable Transactions||7||10||10||10||9.25|
|Reduce Staff-Related Risks||9||8||5||9||7.75|
|Reduce Concentrations of Risk||7||9||6||5||6.75|
|Increase Revenue & EBITDA||10||7||4||4||6.25|
|Sales & Marketing||8||7||5||4||6.00|
|Increase Cost to Replicate||10||6||3||4||5.75|
|Increase Recurring Revenue||10||6||2||5||5.75|
|Strengthen Customer Base||7||4||6||4||5.25|
|Improve Documentation, Infrastructure & Scalability||7||8||3||4||5.50|
Commentary on the Sample Model
Following are our comments on Acme Software’s RVD™ Model. Factors are ordered by priority based on the chart above.
- Increase Pricing (Rating 9.25): The potential returns from increasing pricing were extremely high for Acme. If Acme increased its prices, 100% of the price increase would fall to the bottom line — if Acme increased prices by 20%, EBITDA could potentially double. Revenue was $10 million, and a 20% price increase would increase EBITDA by $2 million, or double EBITDA to $4 million from $2 million. Such an action was considered low risk by Acme and required little time and money to implement. As a result, Acme focused first on this value driver due to its potential for high returns and the low amount of time and investment required to implement it.
- Document Comparable Transactions (Rating 9.25): Acme was aware of several transactions that occurred within their industry that had higher multiples (7.0 to 8.0), but they had no documentation to back up the multiples their competitors received. Acme believed they could obtain more information regarding the transactions through several well-connected individuals in their industry, as well as through their investment bankers and professional advisors. While the potential return from this value driver was less than that of increasing pricing, little in the way of time and money was required to obtain this information. As a result, they began executing this value driver immediately after they increased pricing.
- Reduce Staff Related Risk (Rating 7.75): Acme had several key employees who lacked employment agreements, confidentiality agreements, and non-solicitation agreements. They understood this represented a significant risk to a potential acquirer and realized this could be cleared up with minimal cost in a matter of several weeks. Acme asked their attorney to prepare employment agreements for key staff that included non-solicitation agreements with a retention bonus to ensure the employees would be retained in the event of a sale. The retention bonus served as a form of consideration (required for contracts) that improved the enforceability of the non-solicitation agreement.
- Reduce Concentrations of Risk (Rating 6.75): Acme also had key employee, customer concentration, and product concentration risks. While these risks could not be immediately mitigated, plans could be put in place to mitigate these risks over time. Key employee concentration was mitigated by more evenly spreading duties across the management team. Customer concentration risk was also mitigated by asking key customers to sign long-term contracts. Finally, product concentration risk was mitigated by developing strategies to invest more in marketing their entire product line, as opposed to just a few products.
- Increase Revenue & EBITDA (Rating 6.25): While the potential impact of increasing revenue and EBITDA was significant, doing so involved a considerable amount of time and investment. Acme realized that the primary method for increasing revenue, and therefore EBITDA, was to hire a more experienced sales manager and invest in building the sales infrastructure so the sales team could scale up their impact on the business. This required a significant investment in time and money, as well as a reasonable level of risk. However, the risk was mitigated by hiring a third-party expert to help interview and screen potential sales managers.
- Code Audit (Rating 6.25): Acme’s owners had some background in development, but they were not 100% sure the software (code) was clean and well documented. They realized a buyer might retain a third party to conduct a code audit during due diligence and they reasoned that it would be a wise investment to hire an independent firm to conduct a code audit before they began the sale process. The audit cost approximately $15,000, but they felt the investment was justified given the potential impact on improving the certainty of closing once a buyer was located.
- Strengthen IP (Rating 6.25): Acme’s name was well respected and known in the industry, and they felt they could obtain a trademark. They also lacked invention assignment agreements for their developers. They hired an intellectual property (IP) attorney, at a cost of $25,000, to perform a trademark search, file for a trademark, and prepare invention assignment agreements for key staff. The process was expected to take approximately 4 to 6 months. While doing this wasn’t expected to significantly impact their valuation, it did mitigate risk for the buyer and, therefore, could reduce the due diligence risk for Acme.
- Sales & Marketing (Rating 6.00): Acme lacked sales and marketing documentation and infrastructure, and they realized this might take a significant amount of time and money to build. Since the potential impact was not as substantial as value drivers higher on the list, such as increasing pricing and reducing staff-related risk, they gave this value driver lower priority given the amount of time and money required to execute it. Acme assembled a team to document the sales and marketing processes, expecting this process to take approximately three months.
- Increase Cost to Replicate (Rating 5.75): Acme felt that a few competitors could easily replicate the functionality of their software, but they felt they could implement several defensive strategic actions that could make any replication more difficult. Acme implemented these strategies over a period of three months.
- Increase Recurring Revenue (Rating 5.75): Acme’s enterprise customers’ agreements were renewable annually and many customers stalled during the renewal process. Acme felt they could create an incentive to motivate customers to sign an automatically renewable contract. Still, this transition process would take at least one year as they thought it would be best for customers to sign the new contract upon the expiration of each annual contract. Acme began implementing this process simultaneously while documenting their sales and marketing processes since they realized that transitioning to automatically renewable contracts would take time.
- Strengthen Customer Base (Rating 5.25): Acme lacked agreements with the majority of its customers and realized this represented a significant risk to a potential buyer. Acme created several pricing models with various contract terms and tested those models over a period of ten weeks using a combination of minimum viable products (MVPs), sprints, and A/B testing. Acme’s goal was to create a pricing model that incentivized customers to sign long-term agreements.
- Improve Documentation, Infrastructure & Scalability (Rating 5.50): Acme lacked documentation and infrastructure that could help it quickly scale, but they realized that improving the documentation and infrastructure would require an enormous investment of time and money — perhaps up to nine or more months. They also realized that this work would distract their employees from other projects. As a result, they decided this was their lowest priority value driver and planned on executing it as their last priority.
Tips for Completing the RVD™ Model
The Importance of Prioritizing the Value Drivers
Note that for Acme, while there is considerable subjectivity regarding the individual criteria (return, risk, time, investment) and the overall rating for each value driver, there is a clear distinction between the highest priority value drivers and the lowest priority value drivers — based on the overall rating. Priorities are not absolute but should be considered relative to one another. The individual ratings aren’t important — what is important is the overall ranking or priority of the value drivers relative to one another. For example, it’s clear from reviewing Acme’s RVD™ Model that increasing pricing should be prioritized over improving documentation. Because completing the RVD™ Model is simple and requires little time, Acme could perform this analysis in a few hours, with the assistance of an M&A advisor, and could begin executing the top value driver within days. There is no need for extensive planning and procrastination — the RVD™ Model encourages lean planning and action, emphasizing results.
The Importance of Perspective
Don’t restrict yourself to a linear, black-and-white approach. The purpose of the RVD™ Model is to offer you a high-level perspective of your available options and the associated criteria in deciding your course of action. Once you perform your rational analysis, let your subconscious take over to see if more strategic options evolve. Review your potential value drivers several times and re-rate them from scratch several times to uncover inconsistencies or areas where you may need more information.
The Importance of Obtaining Multiple Opinions
For a more democratic approach, consider giving a copy of a blank RVD™ Model to your C-level executives and M&A advisor to complete independently. By asking them to complete it independently, you will counteract the bandwagon effect. Or consider showing your value drivers model to your professional advisors, such as your accountant and attorney, for their input. Don’t show a copy of your completed model to those who are completing it for the first time. Asking others to complete the model blind (without seeing your completed model first), will unveil important assumptions your advisors may have regarding some of the value drivers. For example, a CEO may have a different perspective than the CFO, CMO, or CTO.
The Importance of Reconciling Different Opinions
Once you have obtained multiple opinions, combine the results into one spreadsheet, and discuss the reasons for any differences with your team and advisors. By carefully weighing everyone’s opinion, the model flushes out differing opinions and helps prioritize those actions that everyone believes could have the greatest impact, and that could be executed for the least cost, time, and risk. In other words, openly debating the model will result in a course of action based on input from your team.
The Importance of Assembling a Deal Team
It’s helpful to assemble a deal team to initially discuss the value drivers and formulate and execute the strategy. Once your deal team is established, develop a daily cadence, and use principles from Scrum and Agile (lean) development to improve your speed and iteration time. The more help you have to execute the value drivers, the more progress you will make. This may also be a wise time to consider implementing a retention bonus plan for your key executives. A retention bonus will help to align incentives and motivate your key staff to improve the value drivers, especially if the amount of their retention bonus is tied to the purchase price.
The Importance of Breaking Value Drivers into Specific Action Items
Finally, consider breaking the value drivers down by specific actions, such as creating a retention bonus for key employees, as opposed to themes or categories, such as staff. Ratings, and therefore priorities, may be significantly different for specific actions as opposed to categories of actions, and it may therefore make sense to rank the model by specific actions as opposed to categories.
Value Drivers & Reasons for Acquisitions
In addition to ranking the value drivers, it’s helpful to know why a company may desire to acquire you. Knowing the reasons a company may buy you will also help you fine-tune the ranking of your value drivers.
Identifying your value drivers is an important element in increasing the value of your business and preparing it for sale. Systematically improving your value drivers will push you into the upper limits of valuation for your company. Once you have identified your value drivers, it’s important to prioritize your value drivers and execute them based on their potential impact (return) and the risk, time, and investment required in achieving them.
Not only can improving your value drivers increase the value of your business, but it can also dramatically improve the certainty of the close. While working to maximize your value drivers is not an absolute requirement for selling your business, it can significantly improve the value of your business and help ensure the sale process transpires as smoothly as possible.