Here are some items you should consider to get the best price when you sell.
Most privately held business owners view their business value as a multiple of cash flow, EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) or multiple of Benefit to Owner. Business owners typically hear multiples in the range of 3 to 7 times one of these cash flow metrics as a means for business valuation. For example, a company with $3,000,000 in EBITDA at a multiple of 5 would be worth $15,000,000 plus the value of real estate and some other assets. A lot of other factors will go into the offer price that will typically result in the value of the business being less than the owner anticipates. You should consider all of the factors that create value for your business long before you ever make the decision to sell it. This will help establish a much better price at the time of your sale.
What else should I consider that impacts the value of my Business?
Sophisticated buyers and business valuation experts will consider far more than just cash flow and will look in depth at an extensive list of items that impact the true value of your business which typically will include the following:
- Type of business – This would be the industry served – professional, service, retail, wholesale/distribution, manufacturing, construction, agriculture, bank/financial service, medical, etc.
- The proprietary content of the business – Highly proprietary, moderate, or low.
- Industry life cycle – mature industry, growing industry, a declining industry.
- Industry stability – Stable, unstable, highly volatile.
- Strength of the business in its market – strong & growing, stable, declining.
- Overall size of the business market being served.
- The relative size of your business to the market – One of the largest members of the market, in the top 20% of the market, or some other size.
- Business Risk – % concentration of sales in the top 5 customers. The higher this percentage the riskier the business is and the lower the valuation is likely to be. If this number is over 70%, diversification of your customer base is essential to reducing risk and increasing value.
- The relative quality of your goods and services to others in your market.
- Product differentiation – Highly unique, somewhat unique, no differentiation/generic.
- Market area – Local, regional, national, international.
- The number of employees and your employee turnover rate. Remember that high turnover is always more costly than you first think.
- The number of highly skilled employees needed to run your business.
- Whether or not your workforce is unionized. Believe it or not, in some cases, being unionized can be a positive rather than a negative. It depends on your business and what benefits unionized employees bring to the business.
- Management depth and quality, excluding the current owners. This will be discussed in more depth later.
- Facility quality, productivity, and throughput.
- Ease of entry into your market – barriers to entry.
- Quality of information technology and documented business processes.
- Are your business processes auditable? This includes being able to get an Audit or Review of your financial statements by an independent public accounting firm.
- Buy/sell agreements between current owners.
- Non-compete agreements with key employees.
- Current litigation, if any.
- Patents, trademarks, copyrights or other intangible assets your business owns.
- Quality and type of board of directors and frequency of meetings. Many privately-held businesses have a board of advisors rather than a board of directors. Having either is viewed positively by potential buyers.
As you can see from the above list, the value of a business includes far more than just a simple multiple of cash flow. The answer to each of the items above will impact the overall value of your business either positively or negatively. Any one of these items can cause the value to decline or increase.
What else should I consider that purchasers seek?
- Ability to run as a standalone business WITHOUT the owner – Remember the item above concerning the quality of management excluding the owners? This is a key component of creating business value. If the ability of the business to maintain current revenue is largely dependent on you, the owner driving the business, then the only thing you really have for sale is a customer list that will have nothing near the value of the business cash flow times a multiple.
Ask yourself a very difficult question. If you were unable to run your business tomorrow, can your business continue to grow and prosper with the current management and staff that you have in place? If you cannot, without any hesitation, say yes, then you have a very significant problem that is adversely impacting the value of your business. Ask yourself the reverse question – if you sold your company, how long will the buyers have to keep you to support the business? If this greater than an orderly 6-month transition, you are too vested in your business and do not have the correct management in place.
- Process, procedures, and policies – A well-run business of almost any size should have documented business processes, daily operational procedures, and written policies that support both the business processes and procedures. This does not need to be overly complicated, in fact, simple and easy to understand is better than big binders loaded with policies that never get read. A potential purchaser will find paying a higher multiple easier to justify if these are well documented and a transaction audit shows that they are being followed by all levels of employees.
- Growth rate – If your company is showing consistent growth in revenue and income over the last 3 to 5 years you can expect to receive a better offer at the time of a sale versus a company that is showing stable but flat sales or worse yet declining sales. If your company is not growing, you should develop a plan to reverse this trend immediately starting with improving sales growth.
- Clean Financial Information – Keep your personal expenses out of your business. The less a potential buyer needs to adjust your cash flow the better your business is perceived by the buyer and the more they will be willing to pay a higher price. Running personal expenses through your business that result in significant adjustments to true business cash flow may save you on taxes but could be costly as your business is being evaluated by potential buyers.
What can you do to improve the value of your business?
- Start now with a plan. Do not wait. Now is the best time to start putting a plan in place to increase the value of your business before you are ready to sell. Do this even if your time horizon is out 10 years or more. Any changes in this direction that you make will likely enhance your company’s value, but the immediate benefit is that your company will become a better-run enterprise. It’s this fact that increases your value, so why not get started on your plan?
- Set a baseline, consider having your business professionally valued by an AICPA certified valuation expert. You can get a professionally prepared valuation completed for $7,000 or less. This will give you a baseline to determine if the changes you are making are helping increase value. Consider doing this again in 3 years to validate you are making progress in improving your business’s value. While buyers will consider a whole host of items that may not be addressed in such a valuation report, the report is still helpful because it gives you an unbiased outsider’s professional view of the value of your business.
- Improve your management. If you could not affirmatively answer the question that your business can run without you, start now to determine what management changes must be made to positively resolve this major issue. Many times loyalty gets in the way of this process, but this requires a lot of objectivity.
- Build a support team. If you do not have a board of directors, consider setting up a board of advisors to help you with resolving all of these issues. Have your board made up of your corporate attorney, your tax advisor and several trusted business owners, both in and out of your industry, that do not compete with you. Consider having quarterly board meetings with a formal report to the board showing what improvements have been made since the last meeting and what needs to be completed over the next quarter. This will help hold you accountable for moving forward and solving problems at the company level. I have clients that insist this has been the single biggest driver that helped them improve their business and its value.
- Contract with skilled professionals. Consider hiring consultants to help document your current business processes, improve them if necessary and set up key performance indicators (KPI’s) to evaluate your business daily, weekly, and monthly. Any of Nperspective’s partners would be pleased to help you with this. We have established relationships with area bankers, accounting firms, law firms, human resource managers, and other professionals that we can refer to you on an as-needed basis to help improve the operations and subsequent value of your business.
To obtain the value that you expect for your business, it is important to invest the time to get it ready to sell. You may have “a number” in mind, but you need a process to make that a reality. These simple steps will help you before you want to consider selling your business and will help you obtain the valuation you deserve for all your hard work when the time to sell arrives.
Even if you are not selling, if you cannot answer these questions favorably it means that some level of improvement to your business is needed now to maximize cash flow and future value. Remember, because of the business valuation multiples, every dollar you invest to improve cash flow will generate a far better return than almost any other investment vehicle at your disposal. One of the biggest advantages of being a business owner is that you can generate significant returns from the investment of your time and financial resources. It is arguably the best investment opportunity that you’ll ever have.
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