If you had to look at a number of companies and determine which company has the best prospects for the future, could you pick it? The methodologies for small and mid-market companies (up to $100 million in revenues) are slightly different than for large companies, but the principles are the same. In addition, if the company is a potential acquisition, then other factors must be considered.   When evaluating for acquisitions, you must consider any synergies between the companies. The value proposition may be greater when the company is combined with another because of increased market strength, cost advantages, products or services that are complementary, or an extension of geographic range. This discussion will focus on evaluating individual companies to determine which company will be the best one over time and not which ones would necessarily be the best acquisitions.
What is a winning company? It depends on whether you are an investor, acquirer, or employee.   Some characteristics of a winning company are a high return on equity, sustainable and consistent growth in revenues and earnings, growth and size of market value, possibly a market leader, a company that consistently offers products or services that are in alignment with customer needs and wants, and one that makes modifications to stay at the forefront of the market.
As part of the analysis of a company, it is helpful to do a valuation. There are 3 basic approaches to valuations. They are:
  • Income approach – there are several different income methodologies. Discounted cash flows are typically used. Expected income and risk adjusted returns are taken into account.
  • Market approach - Revenue or EBITDA multiples of comparable businesses may be used, with adjustments for risk or particular strengths of a business.
  • Asset approach - This views the business as a combination of assets and liabilities that can be used to get a picture of business value. It is based on the economic principle of substitution which examines the cost to create a similar business that can produce the same economic benefit or utility.
There are many quantitative and qualitative factors that must be considered in an evaluation.   Some factors will be more dominant than others. To determine the weightings, you must have an understanding of the industry and critical success factors of companies within that industry.   Evaluating small and mid-market companies is different from large companies, but the basic principles are similar.
Early in my career, I was one of 30 people involved in strategic planning and corporate development who were invited to a session by consultants to determine our abilities in evaluating companies. We were given a large amount of quantitative and qualitative information about 5 large corporations (only identified as A through E). We were told that this information was from 5 years prior to our session and we had to pick the company that was the best performer and the worst performer after 5 years. We were given 60 minutes to independently analyze the information. I was the only one out of 30 to correctly pick the best and worst companies. Plus, I presented my rationale for the selections. What I discovered is that you have to determine weighting of information as well as what is relevant and what is not.   Using a combination of business acumen and analytical skills, you can reasonably predict the winner and the loser.
There are 6 areas that must be considered in evaluating the prospects of a company.   Quantitative and qualitative data should be collected and analyzed. The 6 areas to evaluate are:
  1. Market
    1. What is the size of the market?
    2. Growth of the market – is it growing, mature or declining?
    3. What is the impact of technology and social trends on the market?
  2. Competitive Landscape
    1. Is it highly fragmented or are there one or more companies dominating the market?
    2. What are the strengths and weaknesses of the competitors?
  3. Company’s position within the market
    1. What are the strengths?
    2. What are the weaknesses?
    3. Is it a market leader?
    4. What is the market share compared to its competitors?
    5. What are its competitive advantages?
  4. Operations
    1. Are the processes effective and efficient?
    2. Are there any issues in the production of products or development of services?
  5. Strategy
    1. What is the company’s growth strategy? Acquisitions or organic growth?
    2. Are the marketing plans effective?
    3. Are the operational strategies effective?
  6. Management
    1. In a small or mid-size company, the effectiveness of the management team can be evaluated more readily than in a large company.
    2. As the economic and market factors change, how does management react to the changes? For instance, a decline in revenues may occur because of market or economic conditions. Does management react in a way that helps the company remain profitable and still postured for future growth? Cutting expenses is a great short term solution that can have detrimental long-term consequences if not done properly.
    3. Is management being rewarded only on short-term results or are there long-term incentives in place?
    4. Does the corporate culture contribute to growth and value maximization?
    5. Do they respond to customer needs effectively?

When we evaluate a company, we look beyond the historical growth rates. We need to look at how the company changes its products and services in response to changes in customer trends, market trends, and technology changes. In addition, is the company agile and able to change its course when necessary? Plus, we have to determine what changes are occurring in the market and business environment that will affect the company.   Therefore, we are evaluating a number of internal and external factors that affect an enterprise.
With business experience and acumen combined with experience in analyzing and evaluating many companies, you will be able to recognize the potential winners.
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