Once you have prepared yourself for your transition and calculated your “wealth gap,”or how much money you will need from the transition, it’s now time to think about how much your business is worth. When we talk about “building a better box” in our book, Cashing Out of Your Business, we’re referring to maximizing the value of your business, which is always one of the fundamental components of achieving a successful business transition.
Here are some important factors to keep in mind for building a better box:
Financial Dependence on the Business
Because most owners are financially dependent on their businesses, they will have to tap into that value during their transition and extract the money required for their next phase of life. Most often, this will require boosting business value – sometimes significantly – in order to net the amount they need to fund retirement.
While it can be hard to imagine that a business that’s been around for many years can falter, it happens all the time – and the decline can be dramatically fast.
If your business has been successful for many years, it can be easy to simply rest on your laurels. Profits are high, your lifestyle is comfortable, and after a while, you stop investing the time and resources required to increase value.
Staying hungry in the industry and keeping an eye on the competition will be critical to your continued success. The last thing you want is for the business to stumble just before you transition the ownership to a new buyer.
Beauty Is in the Eye of the Buyer
Understanding how businesses are valued and what drives their value is extremely important. Publicly held companies have a definitive value, on any given day, based on their stock price. By contrast, privately held companies have a range of values on any given day based on the potential buyer’s perception.
Buyers are looking for a profitable business, but also a well-run business with low risk and future potential. Trust us when we tell you that buyers will leave no stone unturned when evaluating your business through a process known as due diligence.
Understanding Business Value
Business valuation is a complex topic, and the professional advisors who prepare business valuations go through comprehensive training and testing to achieve their certifications. We always recommend that owners engage with advisors who are well versed in this field in order to truly understand what their business may be worth.
There are several positive characteristics that buyers will always look for when evaluating your company:
- Increasing Revenue & Profits
- Future Growth Potential
- Clean Financials
- Solid Management Team
- Quality Products & Services
- Strong Sales & Marketing
- Low Risk
- Updated Systems & Processes in Place
For more tips on what buyers are looking for, you can read our articles:
If you make it through the ‘sniff test’ and initial diligence and get to the offer stage, the purchase price will often be stated as a multiple of normalized earnings (often referred to as ‘Adjusted EBITDA’ or Earnings Before Interest, Taxes, Depreciation, and Amortization). The process for normalizing your earnings involves starting with your internally reported earnings and adding back non-cash expenses, interest, income taxes, non-recurring expenses, as well as your excess compensation and personal expenses that may be on the company books – club memberships, vacations, payroll expenses for absent family members – you get the idea.
The goal is to determine what someone “off the street” could earn if he or she bought your business. Normalized earnings is then subjected to a multiple based on the buyer’s perceived risk and desired rate of return to arrive at a purchase price or value for your business. Multiples can vary widely across industries, company size (larger companies typically command higher multiples), and market conditions (lower multiples in buyers’ markets and higher multiples in sellers’ markets).
The bottom line is that buyers will apply higher multiples to quality companies. If you work hard to improve your business, buyers will be willing to pay more for it. Due to the multiple effect, every dollar you add to the bottom line earnings will come back to you many times over in the purchase price. Planning in advance will give you time to improve your business and maximize its value.
Make Sure Your Business is Ready
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 begins.
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.
Cashing Out of Your Business
Cashing Out of Your Business, co-authored by BTA co-founder Jane Johnson, is written especially for business owners. It introduces the concept of business ownership transition planning and outlines the six steps that may be used by all owners to analyze their current situation, determine their goals, and design a Business Ownership Transition Plan that is custom to their needs.
Planning early for your business transition will enable you to have the optimal outcome and a greater chance of achieving your goals. You will be able to determine exactly what you are trying to achieve with your transition, increase the value of your business, decrease your financial dependence on the transition, and maximize the net monetary “take” from the transition.