How can you maximize the selling price of your business as a business owner? Whether you’re on the cusp of selling your company or a potential transaction is still years away, this is an important question to answer.
Why? Because even small changes can sometimes translate into big dollars upon exit.
Many business owners are very good at the role they play in their business (usually managing it), but they may not have a clear grasp of what creates financial value from a buyer’s perspective.
These five principles from business valuation can help shed light on how you as an owner can make improvements to your business that can potentially add value in an exit.
Principle 1: All else equal, higher profitability will increase the value of your business.
In its simplest form, the value of a business is based on the future benefits that will accrue to its owner.
Intuitively you already know that the higher the cash flow, the higher the benefits to an owner – and the more the business is worth.
Low margins are never terribly attractive; however, if you can show that margin improvement is underway, you may be able to create some additional deal value even if your company has more work to do.
- How profitable is your firm now (e.g. gross margin, operating margin, EBITDA, net income)?
- Does your company compare favorably or unfavorably to industry averages?
- What changes would you need to make to be at or above the industry averages for profit?
- Which of your products or customers are the highest margin?
- How can you reduce expenses in a way that enhances, or doesn’t harm operations?
Principle 2: All else equal, higher growth increases your company value.
Growth is a core component of value. A buyer will want to understand your company’s historical growth.
How fast have you grown? What was the mix of organic growth versus acquisition-driven growth?
More importantly, they’ll look for clues on how your company can grow in the future during their ownership. Are the best days behind the company? Have you taken a wild ride to the top, but now the market is saturated?
Or has your company just proven it’s viable in the marketplace and has a disruptive product with lots of market share to take? An informed buyer will want to carefully understand how big your company can get and how fast.
- How fast is the company growing (e.g. revenue, EBITDA, net income)? In the last year? Last five years?
- What’s driving your company’s growth or decline?
- What trends, new markets, acquisitions, etc. can you leverage to increase long-term growth?
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Principle 3: All else equal, larger size increases the value of your business.
Why is it that a company doing $500 million in sales can be worth more than adding up 100 stand-alone companies each doing $5 million in sales?
The answer is that large companies often have characteristics and advantages that make them more valuable than their smaller counterparts.
Larger companies tend to have more diversified product lines. They often have more clout with and easier access to suppliers and large customers. Typically, they can lower their cost of capital with easier access to debt markets and the ability to go public.
Large companies also tend to have robust professional management teams and key company knowledge is spread widely throughout the organization.
All of these factors tend to increase the ability of a larger company to earn more money, lower their risk, or both.
- How large is your company (e.g. revenue, net income, assets, etc.)?
- How can you grow the size of your company?
- Do acquisitions make sense for your business?
- How can you diversify your company in a way that improves operations (e.g. management team, customer base, supplier base, product focus, etc.)?
Principle 4: All else equal, taking on a reasonable amount of debt increases value. Taking on too little or too much debt can reduce value.
At a high level, your company can be funded by debt or equity. The cost of the total capital is determined by the relative cost and amounts of debt and equity in your company.
Since debt tends to be cheaper than equity, your firm can lower its total weighted average cost of capital (WACC) by taking on some debt.
Too little debt and a company relies on more expensive equity to fund the business. Too much debt and the risk of default starts to rise dramatically, increasing overall company risk, which reduces value.
A buyer may acquire all the assets and liabilities of your company (e.g. stock sale), or just the assets while carving out the liabilities (e.g. asset purchase).
In the latter case, they may not care what your current debt load is, but if the buyer is purchasing stock, they’ll be concerned about how heavy your debt burden is.
- How much debt does your company have currently?
- How much debt can your company comfortably support?
- How much would be a struggle?
- What would you do with the equity you free up by using more debt?
Principle 5: All else equal, lower risk increases your company’s value.
You’re already aware that there are many risks that come with running a business.
Common risks include:
- Customer concentration – having a large percentage of revenue coming from only one or a few customers
- Supplier concentration – the company is at risk of being unable to supply product if their sole supplier can’t deliver for any reason
- Key personnel risk – a founder holds a disproportionate amount of customer contacts, proprietary knowledge, etc.
- Risk of competition
- Risk that the economy or industry will move in an unfavorable way
And, the list goes on. A buyer will want to understand all the risks that are most likely to move the needle for your company.
As a seller, if you have a good story to tell about how you’ve already thought about and mitigated the relevant risks, then the buyer may grow more confident and your company value can be increased.
- What are the biggest risks facing your company today?
- What risks are unique to your industry?
- How can you mitigate or eliminate these risks?
These five principles are at the core of a business valuation, and also map to where an informed buyer will look when pricing your company.
Have questions about maximizing the sale price and value of your business? Let’s talk!