Maximizing the Value of Your Business Before Selling

Introduction

If asked, most business owners would probably say that it’s their goal to sell or transfer their business in order to fund their retirement. And the first question they have is: “How much is my business worth?” They may have a vague idea of what they think it should be worth, but often don’t have any tangible numbers to base it on. More often than not, it’s unrealistically high in comparison to what a buyer would actually pay.

This disconnect is very common. In reality, most owners don’t understand the value of their business or how much money they will need for retirement (we call this the Wealth Gap). And, many are unsure about the steps they need to take to increase business value in order to fund the next stage of their lives.

Why Increasing Business Value Matters

It is not unusual for owners to have 70% to 90% of their net worth tied up in their private company ownership, which makes them highly dependent on the sale of the business to provide the cash they need for retirement. In addition, many owners will have to boost the value of their businesses before they transition or they will not net enough money, after taxes and fees, to fund their retirement.  

Let’s look at what constitutes business value, how owners can increase their value, and how they can determine what their business is worth today.

How Businesses Are Valued

Determining business value is not an exact science. There are various methods of calculating value, depending on specific circumstances. For business sales, value is a primarily a prophecy of future cash flows for the prospective buyer, whether the business is sold to an internal or external party.

Buyers want to purchase businesses that generate cash so they may receive a return on their investment. Value will be impacted by the size and industry of the business, its growth potential, risk profile, and quality.

How can you determine the value of your business?

  • Certified Business Appraisals:
    • Prepared by a reputable business appraiser (could cost up to $15K or more)
    • NOT required prior to selling your company, but can be an eye-opener at any time
    • Required for all Gifting, Estate Planning, implementing ESOPs, Shareholder agreements, divorces, etc.

  • Ball Park Range of Values:
    • Typically done by a CPA , business broker or advisor as an informal estimate of value
    • Should be done prior to or at the same time as the creation of a business owner’s exit plan to estimate current value and determine strategies to increase value and bridge the owner’s Wealth Gap

Owners generally will need a certified business appraisal ($10 to $15,000 cost) for gifting, estate or tax planning, divorce, or implementing an Employee Stock Ownership Plan (ESOP). For other planning purposes, you can obtain a cost-effective and simple estimate of value to understand what your business is worth and determine if you will net enough to fund your retirement goals. We urge all owners to obtain a baseline estimate of value so they can determine just how much they will need to grow in order to exit. 

What Buyers are Looking For

Buyers pay more for quality companies. If you work diligently to grow and improve your business, buyers will be willing to pay more for it. There are many factors that will pique a buyer’s interest and drive the best possible price. While owners tend to focus on the top line, which is important, there are many other critical areas that need to be considered. We discuss these areas in our book, Cashing Out of Your Business – Your Last Great Deal.

  • Increasing Revenue & Profits
  • Growth Potential
  • Clean Financials
  • Solid Management Team
  • Quality Products & Services
  • Strong Sales & Marketing
  • Low Risk
  • Systems & Processes 

Three Common Financial Mistakes that Can Decrease the Value of a Business

  1. Focusing on Tax Minimization – Many business owners operate their companies to minimize income taxes. However, this is not the best practice when it comes to maximizing business value. Minimizing taxes while preserving the true profitability of the company makes good business sense, but minimizing taxes by artificially lowering profits can cost you a staggering amount during the sales process. In an effort to pay the minimum amount of taxes, many owners run “lifestyle businesses.” By that we mean the owner seeks to take as much money as possible out of the business in order to fund the family lifestyle and keep his or her tax burden to a minimum. Unfortunately, this money is usually spent on an increasingly expensive lifestyle and is rarely saved for the owner’s future needs. This is actually just a form of consumption, rather than the creation of wealth, which would occur if the business were treated like an investment.

  2. Driving revenue rather than margins – Of course, it is important to have increasing revenue. However, profit margin is often ignored in the process, which can decrease the value of a business. Gross profit margin is the percentage of revenue you retain after accounting for direct costs referred to as “cost of goods sold”. Companies that sacrifice their margins in order to keep gross revenues high reduce their overall profitability and company value, and they weaken their position in the marketplace. One key strategy for increasing margins is to add recurring revenue to your business, such as:
    • Service or maintenance agreements
    • Consumable product or replacement part contracts
    • Subscriptions for products, services, or information
    • Memberships
    Recurring revenue is guaranteed revenue, at least for some time, which does not require the same level of sales and owner effort as one-time revenue. This revenue often has much higher margins and is always highly coveted by buyers. Studies show that businesses with recurring revenue sell at much higher multiples than those that don’t.

  3. Dependence on the business owner – Perhaps surprisingly, revenue is not always the most important value driver. In fact, one of the biggest concerns a buyer usually has about a business is its dependence on the current owner. Not only does this cause a business to be unattractive to a buyer, but it also creates great risk for the current owner. How would that business continue to function and prosper without the owner? Too many times, an owner has the business relationships, processes, procedures, and technical know-how all under his or her control. In some extreme cases, you could actually say that the owner is the business. This is the direct opposite of what appeals to a buyer.

The Importance of Contingency Planning

Buyers are interested in acquiring businesses that are transferable with sustainable profits. A solid management team and successor are critical components of a transferable business but are not always present in closely held businesses. Developing a contingency plan and a strong management team to be sure your business can operate without you will protect you in the event that something happens to you, and it will definitely increase your company value if you decide to sell.

The Multiplier Effect: Small Adjustments Make a Big Difference in the Sale of a Business

For business owners who may be thinking about planning a business transition in the near future, it is important to understand how personal and one-time expenses in the business will impact the value that they will receive. Because the business is worth only what a future owner expects to receive in cash flow from owning the business, it is important to consider the types of expenses an owner runs through the business and how those should be documented for the future owner in order to calculate the true future cash flow.

In the context of selling your business, it is very important to understand the impact of a consumption mentality. Businesses are usually sold on the basis of “recast” cash flows or EBITDA (earnings before interest, taxes, depreciation, and amortization). The process of recasting the earnings involves adding back one-time or non-recurring expenses, along with personal expenses that are clearly documented. Few owners document their personal expenses each year, and most buyers are unlikely to allow such add-backs without it.

Recast EBITDA is then multiplied by a factor called a multiple. This multiple represents a prospective buyer’s perception of the riskiness of your business and the rate of return he or she requires on the investment in your business. The less risk perceived, the higher the multiple; the more risk, the lower the multiple. Multiples vary by industry, by business, and by size of business, and there are many factors that go into the buyer’s thinking.

Let’s look at two examples of how multiples work:

  • Recast EBITDA $1,000,000 X multiple of 5.00 = $5,000,000 potential sale price
  • Recast EBITDA $1,250,000 X multiple of 5.00 = $6,250,000 potential sale price

Note that the small difference of only $250,000 in EBITDA at this multiple represents a $1,250,000 increase in potential sale price or business value. So every $1 of earnings equates to $5 of business value.

In addition to having an attractive EBITDA and projections that demonstrate sustainable earnings, other qualitative factors, including the lack of business dependence on the owner, market share, depth of management, processes, procedures, and intellectual property, can impress the buyer, lower the perceived risk and improve the multiple as in this example:

  • Recast EBITDA $1,000,000 X multiple of 5.00 = $5,000,000 potential sale price
  • Recast EBITDA $1,000,000 X multiple of 6.25 = $6,250,000 potential sale price

As you can see above, due to the multiplier effect, an increase in the multiple from 5 to 6.25, due only to qualitative factors or lower risk, also represents a $1,250,000 increase in the business value or sale price!

Steps You Can Take to Maximize Value

Owners must be vigilant about keeping their businesses competitive and growing in order to maximize value and ensure their largest asset is protected. We advise all owners to perform a detailed review of their businesses well in advance of considering any type of transaction. This exercise will uncover items that need to be addressed and/or corrected long before an internal or external buyer’s scrutiny or due diligence begins. Look for and shore up weaknesses, such as missing corporate meeting minutes, customer bad debts, undocumented policies and procedures, the lack of written job descriptions, insufficient employee non-compete agreements, environmental issues, and so on.

In addition, you should make sure that financial records are prepared according to generally accepted accounting principles (GAAP) and consider engaging a CPA to conduct a financial audit or review, especially if you are planning to sell to a private equity group or public company. Having three years of audited or reviewed financials can position you in a very positive way and drive your selling price higher.

If you have been treating your business as a lifestyle and some of your value drivers are not up to par, it may take years to sufficiently correct these factors and maximize your business value. With ample time and good advice, most businesses can greatly improve their opportunities for selling and the value they will receive. We strongly recommend that owners seek comprehensive, holistic advice in preparation for any sale – whether internal or external. There is no substitute. This is most likely a once-in-a-lifetime transaction, and you cannot afford to make a costly mistake.

Invest in Planning and Reap Your Reward

As a business owner, you’ve spent countless hours and innumerable resources structuring and negotiating deals, developing innovative products and services, and working to serve your customers – now it’s time for YOU to benefit by making your ownership transition your best and most successful deal yet.

Minimizing the risk potential in your business takes time, effort, and planning, which is why we recommend you begin the planning process at least three to five years prior to your desired transition date. By undertaking this process, you will know how to maximize the value of your business and when to sell (either internally or externally) so you can tap into the value, realize your gain, and get enough money to achieve your goals.

The Importance of Business Transition Planning

Based on our experience, we believe the only way to maximize your business value, as well as increase the likelihood for a successful ownership transition, is to be prepared. Being prepared not only involves time and seeking the best advice, but it also starts with owner education and planning.

We recommend that all owners create a written Business Ownership Transition Plan (BOTP) as a roadmap to success. This document outlines how and when the ownership of your business will be transferred to others as well as the important steps you will need to take to increase business value and prepare for one of the most important transaction of your life.

Keep in mind, some changes take more time than others to achieve so you need to consider your desired time frame for a transition. If you have sufficient time, you may be able to improve your business, increase the value and net enough from the sale of your business to fund your retirement. 

Learn How to Sell Your Business for Maximum Value

If your business is not worth enough now, you will need to figure out how to increase the value before you sell. Really valuable companies have increasing revenue and profits, but they also have a strong management team, quality products and services, strong processes and procedures, and much more.

Our member content and tools will:

  • Show you how businesses are valued.
  • Calculate what your business is worth today.
  • Identify multiple ways to increase your business’ value before you exit.
  • Teach you how to position your business in the best possible light.
  • Discuss how you can sell your business internally and still get what you deserve.
  • Help you determine the best time to sell your business.
  • Enable you to understand how your business sale will be taxed so you can estimate your net proceeds.

You may have only one shot at getting what you need from your business sale. Don’t take any chances. Join us to gain the knowledge you need to maximize your business value and secure your financial future.

Ready to find out what your business is worth? Join the BTA free membership program to gain access to our Business Valuation and Analysis tool and much more!

 

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