For most business owners your business is your number one asset.
Do you know how this asset is valued? Understanding this and taking some simple steps prior to exiting may increase its value 50% or more.
What would this mean for your retirement? Banks look at businesses the way buyers do, by asking what the value and the ability of the business is to repay the loan.
Even if you’re not looking to sell, these factors come into play if the business needs capital for growth. Let’s review a few areas where business owners should focus to maximize business value, making it attractive to buyers and the financial institutions that will lend on the business.
Financials
This is one of the quickest and easiest areas to increase the value of the business. The ability of the buyer and the bank to track expenses and understand financial performance is critical to determining value. How is inventory tracked? Are there regular counts? Is it properly booked on the balance sheet or prematurely added to cost of goods? Does the business pay noncritical family members, are there discretionary expenses in advertising, auto, travel, meals and entertainment categories? There will be due diligence conducted by the buyer and a bank. If the financials are not transparent and clear they will discount the value.
Process and Procedures
What are the systems in the business? Is everything in the owner’s head or are they documented? Documenting the process and procedures helps replicate the systems for growth, increases training efficiencies, and reduces errors and mistakes. It helps with accountability and makes for a much easier transition for the new owner. This is why franchise models get a higher multiple for the same industry and are attractive to buyers leaving corporate America. If you don’t have these in place, implementing them will most likely make the business more profitable and should increase your multiple.
Customer concentration
Businesses can easily face customer concentration issues. If you offer a quality product or service and customers continue to place more orders, they could eventually make up a significant portion of your overall sales. If they are over 25% of your business and leave, it will have an impact on your business. Customer concentration is a risk buyers and banks will consider when valuing the business. If you find your business has too much concentration, try to add additional customers. Additional profits would increase value and the reduced customer concentration should increase your multiple.
Management team
Who will be there after you leave? Can the business continue to grow without you? Especially in today’s labor market, buyers will look at the management team and the current employees. Shifting as much day-to-day responsibility of the business from yourself to team members is another important step in making your business more attractive to potential buyers. It gives you more flexibility while owning the business and should help increase your valuation multiple.
These are just a few of the areas that impact value. As a simple example let’s look at what a small increase in cash flow and the multiple can do to the value of the business. Let’s say your business is in an industry that typically sells for a 3 to 5 multiple of cash flow.
Assuming a cash flow of $750,000 and your business is not performing as well in the areas listed above. The market may only give you a 3 multiple for your business.
3 X $750,000 = $2,250,000
Now let’s assume you clean up your financials and improve your systems through process and procedures. Your profitability goes up to $900,000 and the market is willing to pay a 3.75 multiple for your business because of the cleaner books and an easier transition.
3.75 X $900,000 = $3,375,000
That’s an increase of 50% or $1,125,000.
When you adjust profitability and the valuation multiple, it doesn’t take much to significantly increase the value of your business.
Here at Sunbelt Business Advisors and our lower middle market brand, Valens M&A, we help business owners take the necessary steps in maximizing the value of their business at the time of exit.
Contact Ed Krajcir, managing partner, and the team at Sunbelt Business Advisors of Wisconsin and get your free business valuation started. There is no cost or obligation.
125 N Executive Dr Suite #302, Brookfield, WI 53005
(262) 901-0086
