I meet with business owners every day who have spent years, even decades, building their businesses with the hopes of one day selling and retiring. Remarkably, most of them have invested little to no time understanding how business valuations work and what they can do to proactively increase the value of your business.
These five tips will help you not only increase the value of your business but also ensure you’re ready when the time arrives to find the right Buyer.
5 Tips For Increasing The Value Of Your Business
1. Clean up your financials.
If you do anything this year, make sure you stop running personal expenses through the business in order to get as many tax write-offs as possible to lower your taxable income. When a business valuation analyst comes in to review your financials, they will “recast” the financials, meaning they will identify any personal expenses and/or one-time expenses and add them back to the bottom line. However, banks often will not accept many of these “add-backs,” thus lowering your Sellers discretionary earnings (SDE) and, in turn, lowering the market value of your business.
This has a major impact on not only the value of the business, but also the bank’s perception of the business. The bank will be looking at debt-service ratio and metrics to determine if the net profit can provide a livable wage to the Buyer, in addition to safely making the monthly debt servicing payment required for underwriting compliance.
Think of it this way: If you run $10,000 of personal expenses through your business, thus lowering your SDE (Sellers Discretionary Earnings), you’ll get some savings off your taxes. However, if you are hoping to sell your business for three times SDE, just an example, that $10,000 may cost you $30,000 off the market value of your company. Is the tax savings on that $10,000 really worth it?
2. Diversify your revenue.
What’s the most dangerous number in business? One. One source of revenue makes Buyers nervous. If you have multiple services, multiple products or multiple sources of revenue, it provides some assurance to the Buyer, whether real or perceived, that there is stability if any one service offering or product were to be discontinued or disrupted.
The same goes for vendors, customers or contracts. If your company is generating more than 25% of its gross revenue from one source, it puts your business at much higher risk. Future Buyers want to see that revenue is growing year over year, but they want to see diversified revenue growth.
3. Know your numbers.
If you are like me, you love to watch Shark Tank. We all know how upset Kevin O’Leary gets when someone comes on NBC’s Shark Tank and doesn’t know their numbers. O’Leary almost always asks the guest entrepreneur – “How big is the market? How fast is it growing? How many competitors are there? What’s the break-even analysis?” All great questions, by the way.
Knowing your numbers is a quick indicator to a Buyer that you have your pulse on the business, and you are actively managing and aware of what is going on. On the flip side, a Buyer pays for what the business does but may buy it for what it could do in the future. This is important because Buyers rarely pay for potential; they only pay based on past financial performance. However, in my experience, every Buyer factors in the growth potential into their equation.
A good executive summary or “pitch deck” AKA: Confidential Information Memorandum (CIM) to Buyers clearly displays your past performance numbers, but also shows realistic forecasted growth potential. The growth potential can only be justified by clearly seeing what the numbers were compared to and what the numbers are forecasted to be. Having a clear and accurate picture of where the business was and currently is helps paint a justifiable and reasonable trajectory of where it could go. The trajectory is a vital consideration for every Buyer.
4. Get control of your accounts receivable.
In most small business transactions, the Buyer writes two checks: one for the business acquisition and another to fund the operating expenses. If you consistently float your AR for 60 days or more, this severely limits the ability of a Buyer to fund the acquisition and then have sufficient working capital to fully fund the business operations and payroll expenses for the AR period.
Alternatively, if you collect payment upfront or have very short terms of AR, that second check — the check to fund operations — becomes much more reasonable for a Sellers to handle without additional debt. This also pleases the lender backing the deal, which is always a good thing.
5. Establish some form of recurring revenue.
All recurring revenue is not equal, but any type of recurring revenue is better than one-time revenue. Company size, growth history, industry type and many other factors are all part of a standard valuation algorithm that will be used by the Business Broker or valuation analyst to determine the fair market valuation. Whether it’s consumable recurring revenue, subscriptions or contractual revenue, this helps increase the valuation multiple to get an increased overall valuation, which is the ultimate goal.
Bottom Line To Increase The Value Of Your Business: Short Term Sacrifice For Long Term Gain… and Diversify.