Business owners tend to have a parental relationship with their companies. As a result, they commonly have a biased opinion of their company’s worth that can be misaligned with reality.
There is also a myth that the best way to increase the value of your company is to demonstrate a strong track record of revenue growth.
While growing your top line is an attractive trait when it comes time to sell, there are other ways to have a far greater impact on your overall value. To understand how, you first need to understand the value equation.
THE VALUE EQUATION
There are two main components to business enterprise value.
In its simplest form, value is equal to 1) revenue or earnings before interest, taxes, depreciation and amortization (EBITDA) times 2) a multiple.
VALUE = (Revenue or EBITDA) x Multiple
The first component is based on traditional quantitative data and is largely within your control as a business owner. After all, you’re probably already regularly monitoring revenue and EBITDA through your financial statements and positioning your company for further growth in one or both.
However, there is an often-over-looked opportunity to exponentially increase value through the multiple.
VALUE THROUGH A BUYER’S EYES
There’s a two-step process to how a potential investor or buyer assigns value to your company.
In determining value, the first step a buyer will typically take is to use adjust the company’s reported financials for things like non-recurring items and recent changes in revenue streams. This allows the buyer to arrive at a normalized level of revenue or EBITDA.
The second step is to apply a multiple based on a demonstrated market range for the industry and the perceived strength or weakness of your business.
When dealing with a privately held company, the range of multiples applied is driven by factors outside of your control. Things like the present condition of the economy, the outlook of your industry and recent comparable transactions largely determine what this range is.
While you can’t control the range, you can control where in the range you fall. By improving the readiness and attractiveness of your business through qualitative improvements, you can have a hand in determining where in the range a potential buyer will present an offer.
AN EXAMPLE
ABC Services is a consulting firm that has a trailing twelve-month (TTM) EBITDA of $1 million. After adjusting for non-recurring items and owner-specific expenses, a buyer determines that normalized EBITDA is $1.2 million.
The industry for a firm of this size has been trading for between 3x and 7x EBITDA over the past 12 months. Companies perceived as best-in-class are selling around 7x and those seen as highly risky are only trading around 3x, when they’re trading at all.
Using ABC Services as an example, the business has the potential to sell to a third party for between $3.6M and $8.4M. That’s a pretty broad range!
As the owner of ABC Services, which number do you want to walk away with?
The next question naturally is, how do you ensure your company is considered best-in-class?
MOVING YOUR MULTIPLE
In order to move up in the range of value, you must focus on the qualitative drivers of your business.
To a buyer, the purchase of your company ultimately represents an investment. Any investment decision is based on a balance between risk and return. Higher quality businesses pose less risk to the buyer and therefore they are willing to pay more for their investment.
There are eight key qualitative areas of opportunity within a business:
- Planning
- Sales
- Finance
- Leadership
- Legal
- People
- Marketing
- Operations
By improving the quality of these areas, you’ll position yourself as a company that’s balanced and aligned for growth and scalability.
A reputation as a balanced and scalable business improves your chances of receiving multiple offers and presenting yourself as more attractive than competitors. You’ll also move higher in the range of value and likely command a higher price for your business.
The key to executing this strategy is to create a detailed action plan focused on continuously improving in these areas. Some ways in which you can do so are to ensure you have:
- A written and regularly updated strategic plan
- Predictable and recurring revenue streams
- A robust operational framework including documented and repeatable processes
- Quality financial documentation including audited financial statements
- Best-in-class brand recognition and customer loyalty
- Low levels of customer concentration
- A culture that promotes successful recruiting and low levels of employee turnover
- A leadership team that can operate independently from you as the owner
- Appropriate levels of insurance and protection of intellectual property
The best way to evaluate where your business stands today and determine which actions will have the greatest impact on your value is to work with a professional who is versed in exit planning and value acceleration.
They will be able to evaluate and provide a baseline range of enterprise value, rate your company in each of the eight key qualitative areas and provide an action plan that will allow you to decrease risk and therefore increase value.
Finally, don’t forget to align your business aspirations and exit strategy with your personal goals and personal financial plan as well. Value is one thing, but success is another. If you sell your company for an amount that forces you to dramatically alter your lifestyle or you feel a sudden loss of identity post-transition, will you have really succeeded?