The owners of small and medium-sized green businesses may hope for a higher price when they go to sell their businesses because of their exceptional brand value or reputation. But they will be disappointed unless they can make a clear business case to potential buyers according to accepted valuation methods.
A common approach to business valuation, the Direct Market Data Method estimates a company’s value by multiplying its modified annual earnings by a multiplier typical for the industry in which the business operates. Businesses that, as a result of their green strategies, generate sustained higher earnings or merit a higher valuation multipler will be worth more than conventional business of a comparable size in the same industry.
Many green business strategies have a detectable and positive financial impact on small and medium-sized businesses. At the time of sale, these benefits can increase earnings and thus enhance the value of the business. Other benefits are non-financial or their financial impact is difficult to quantify in small and medium-sized businesses. The non-financial benefits can also increase the value of the business but only if business owners adequately define and track metrics that highlight these benefits to potential buyers.
Green Business Strategies can Improve Earnings
As the earnings of a business increase buyers are willing to pay more for it based on a consistent history of cash flow. Many green business strategies improve earnings. Some of the strategies described below generate additional revenue while others reduce costs to the business:
Increased prices – 42% of North American respondents in Nielsen’s survey say they are willing to pay extra for products and services from companies that are committed to positive social and environmental impact, with Millennials being most committed. Companies that sell products from sustainable sources (especially if they are verified by a third party) may be able to sell them for more than conventional products. The increased income can translate into improved earnings.
Energy Costs – Companies that focus on reducing their own energy consumption not only help the environment, but also reduce their costs in the form of lower energy bills. According to EnergyStar small businesses that invest strategically can cut utility costs 25 percent or more without sacrificing service, quality, style, or comfort. Energy-intensive companies like manufacturers may be able to save even more.
Cost of Goods – Waste has a negative impact on a company’s bottom line. Excess supplies and waste materials increase cost of goods. When materials aren’t used efficiently and become waste—companies have to pay again to collect and haul the waste away, further eroding profitability. Preventing waste of energy, water and materials in a company’s operations not only saves resources and reduces pollution, it saves money.
Wage Costs – Businesses that engage their employees and create a positive work culture tend to have more productive employees. According to an article in the Harvard Business Review a positive work culture creates more productive employees. This does not necessarily mean that these businesses provide more benefits for their employees. They simply provide more social, empathetic and respectful workplaces. Increased productivity can help green businesses be more competitive by lowering wage costs per unit of product. The Center for American Progress estimates that replacing a single employee costs approximately 20% of that employee’s salary.
Capital Expenditures – State and Federal government offers incentives at a state and federal level to businesses in the form of tax breaks and credits. The Database of State Incentives for Renewables and Efficiency provides many state and local programs to help green businesses with energy costs and capital expenditures. Companies that take advantage of these government programs are able to investment more resources to stimulate growth.
Green business strategies that systematically reduce costs or increase revenue improve overall company financial performance. If enhanced earnings are sustained over time these green strategies will also enhance the valuation of the business.
Green Businesses with Strong Brands Sell at Higher Multiples
The other factor that the Direct Market Data Method uses to determine the value of a company is the valuation multiple. The multiple for a particular company typically falls within a range based on the size of the company and the industry in which it operates. Businesses that are perceived to have weak brands, are unstable and more risky can expect to sell at the lower end of the multiples range. Businesses that have strong brands, are more stable, and are less risky investments can expect to sell at the higher end of the multiples range.
Notable exceptions occur when a strategic buyer sees exceptional potential to benefit from an acquisition and offers a multiple that exceeds the range. There are many cases when a conventional business, to improve its brand, has acquired a green business for an out-sized multiple.
Often businesses that utilize green business strategies possess the intangible characteristics that would merit higher valuation multiple but their strengths are not adequately tracked or highlighted. Some of these strengths are:
Attract top talent and retain employees– There is strong evidence that green businesses are able to attract top talent and improve employee and customer retention, especially among millennials. More than two-thirds (67%) of respondents in Nielsen’s third annual global online survey on corporate social responsibility say they prefer to work for a socially responsible company. According to Edelman’s Good Purpose report, 71 percent of global consumers said they would help promote products and services that have a good cause behind them.
Reduce operational risk – Owners of small and medium size companies are often most concerned about market risk, however these businesses also face significant operational and compliance risks. Small and medium-sized businesses that implement green business strategies like local sourcing of materials tend to be more resilient to currency fluctuations and supply chain disruptions and are exposed to less regulatory risk.
Increase customer loyalty – A recent global study found that 94% of consumers would be more likely to trust a company that had a strong social responsibility program and 93% would be more loyal to the company. These findings underscore that consumers are increasingly shopping with their values, particularly when it comes to social responsibility.
Track Metrics that Justify Value
Although the benefits for a business that implements green strategies may be real, a cursory assessment of the business will not reveal its strengths. To justify higher multiples at the time of sale green business owners must be diligent to define and track metrics that highlight these non-financial benefits to prospective buyers.
The important metrics will depend on the company and industry, but some to consider are:
Ability to attract and retain top talent
- Expressed interest from qualified candidates for open positions
- Overall employee retention rate
- High performing employee retention rate
Reduction of operational risk
- More uptime
- Fewer compliance fines
- History of employee safety records
- Records of certifications and third party audits
Customer loyalty and brand strength
- Repeat vs new customers
- Customer satisfaction and brand awareness surveys
- Longevity of key customer relationships
The owners of small and medium-sized green businesses may hope for a higher price when they sell their businesses because of their exceptional brand value or reputation. Green business strategies may improve financial performance which over time would logically result in a higher valuation. However, the less tangible strengths of green businesses such as employee retention and customer loyalty will not be recognized in the valuation by potential buyers unless the owner, using defensible metrics, can make a clear business case for considering them.