In our post, The Disconnect Between Owners’ and Buyers’ Perception of Business Value, we discussed that it’s quite common for owners to believe that their business is worth more than what potential buyers might be willing to pay, which can become a big issue for owners looking to sell their businesses. After all, they have spent most of their time, money, and effort on starting and growing their companies. How could others NOT value what they have built?
Owners who are thinking about selling their businesses need to be prepared, consider all of the factors of what comprises business value, and understand what their business is worth from the point of view of prospective buyers in the marketplace. Business valuation is a prophecy of future cash flows for the prospective buyer, whether internal or external; buyers don’t want to buy businesses that will not generate cash. Publicly held companies have a definitive value on any given day based on their stock price. Privately held companies have a range of values, on any given day, which will be substantially driven by the type of buyer as well as the financial performance and quality of a business. The following characteristics contribute to the value of a business:
- Increasing Revenue and Profits
- Growth Potential
- Clean Financials
- Systems and Processes in Place
- Quality Products and Service
- Strong Sales and Marketing
- Low Risk
- Solid Management Team
Companies on a growth trajectory that can demonstrate increasing cash flows through new customer acquisition, current customer retention, and increasing market share are always much more attractive to a buyer than those that have shown little growth or those that are merely keeping pace with inflation.
The size of a company is also a significant factor in the value of a business, since a prospective buyer assumes a larger company has less risk than a smaller company. A company that has been able to achieve $10 million or more in gross revenue, while maintaining solid margins is viewed as a better opportunity than a company of lesser size. In the buyer’s mind, these larger and more successful companies are more likely to inherently possess the characteristics of quality businesses.
How can you determine the value of your business?
Certified Business Appraisals:
- Done by a reputable business appraiser (could cost up to $15K or more)
- NOT required prior to sale of company, but can be an eye-opener at any time
- Required for all Gifting, Estate Planning techniques, implementing ESOPs, Shareholder agreements, divorces, etc.
Ball Park Range of Values:
- Typically done by a CPA or business broker as an informal estimate of value
- Should be done prior to or at the same time as the creation of an ownership transition plan to estimate current value and determine strategies to increase value and bridge the owner’s Wealth Gap
A company that has prepared itself will be valued higher and will be well positioned to take advantage of a selling opportunity when it arises. Many business owners think they can simply pick an age when they want to transition and they wait too long to put a plan in place. They are unaware of business sales cycles so they often miss their prime sale opportunity and have to wait for the next cycle. For some owners, this may be too late. Health or retirement plans can force them to sell in a less-than-optimal situation and cycle resulting in a lower multiple and far less transaction value.
At some point, all owners will have to pass the torch to others, either internally or externally, or face liquidation. So, you want to be prepared. To ensure continuity and receive what you deserve for all of your years of hard work, you will have to prove the value of your business to potential buyers. Carve out some time before year’s end to put your plan in place.