Preparing your business for sale and viewing your asset from the buyer’s perspective.
My clients often ask – “What are the key elements I need to undertake to increase the value of my business for sale?”
Establishing (and increasing) business value is important for many reasons. During your time running and growing the business, you must insure that it generates a regular income which pays for our daily requirements. This is often a big ask in itself, particularly in ‘start up’ years. Ultimately, the business must also build in discernible value, funding our dream lifestyle and happy retirement.
Unfortunately, we can only unlock the wealth accumulated in our business when we come to sell it. And as 80% of businesses do not sell, business owners often have little choice but to walk away from their businesses without a relied-upon nest egg for retirement.
As you can see – it is crucial to not only have a business that takes care of daily costs – but one that increases in saleable value. Now is the time for you as a business owner to change your perspective to that of the buyer by asking the following question.
How can I structure and nurture my business in order to make it attractive to potential buyers?
A potential buyer’s paramount consideration is to evaluate a business’ likelihood to maintain its current profitability under new ownership. In other words how “risky” is the business and “how sustainable is the business performance?“.
The Drivers of Business Valuations
There are several different methods of business evaluation. In today’s blog I will use the EBIT Multiple Valuation method, which clearly illustrates the benefit of adopting a buyer’s perspective.
In the EBIT Multiple Valuation method, the Selling Price for the business is derived by multiplying the ongoing business Profit by an appropriate Valuation Multiple.
Selling Price = Profit times Valuation Multiple.
For example, a business that generates $500,000 Profit per year and has a Valuation Multiple of 2 should achieve a Selling Price of $1million.
$1,000,000 = $500,000 X 2
The drivers of profit are: revenue, costs and growth opportunities etc. In most cases these drivers are already the key focus of business owners. In contrast, the drivers of valuation multiple are risk and return, and these are not always top of mind.
For example, a business with high risk and limited potential will have a low multiple while a business with low risk and high potential will have a relatively higher valuation multiple.
Reducing Risk Pays Off!
Our analysis reveals that a business which is totally reliant on a business owner to win customers or manage daily tasks is highly risky and normally generates 1.5 to 2 times Valuation Multiple. In contrast a business that has developed systems and accountabilities has much less purchase risk and can generate 3 to 4 times Valuation Multiple.
It is often easier to drive up business value by reducing the purchasing risk for potential buyers than by improving the profit. As potential buyers become confident in generating equivalent profit after they buy the business, the higher the multiple that they are prepared to pay.
Optimising your Business Value
Many owners discover they are not adequately prepared to sell their business when it comes to exiting, which results in a loss of their business wealth. To address this, the process of optimising a business for sale needs to start a few years in advance of your planned exit.
In my experience, the following key questions should be addressed during your Business Optimisation Process. When you can answer positively to these questions, your business is well-placed to attract a strong sale result. This is because you will have attended to both the profit and risk drivers that propel your selling price.
- Do your employees understand your business vision and how it supports your business strategy?
- Is the business currently profitable with a history of proven results?
- Does your business have strong growth prospects and is the management team implementing strategies to realise this potential?
- Does your business have goals and metrics in place to measure progress and does it undertake corrective action when required?
- Does the business rely heavily on a few key individuals and are they committed to the business for the medium term?
- Are the internal processes well documented, effective and sustainable?
- Are there strong governance and compliance policies in place?
In summary – to unlock your business wealth, you need to take the following actions.
- Take time to view your business from the perspective of a buyer and gain new insights.
- As well as focussing on drivers that increase profit, you need to address business risk issues that could make your business unattractive to potential buyers.
- A business sale can be overwhelming and complex, so consider the value of hiring business professionals to assist you.