There is never a bad time to enhance the value of your business. If you are contemplating exiting your business in the next few years, value enhancement should be on your front burner. And even if your business exit is still a long way down the road, maximizing the value of your business is still smart thinking.
You never know when circumstances might expedite your exit, and being prepared is not just a “Boy Scout” thing to do. We like to look at business value from the perspective of a potential purchaser, and commonly evaluate 54 different value drivers that are relevant to most businesses. In this article, we will look at ten of those value drivers – each is a characteristic of a business that either reduces the risk associated with owning it, or enhances the likelihood that the business will grow profitably in the future. Improving your business’ performance in these areas will generally allow your business to sell at the higher range of multiples generally associated with your industry.
- Stable and Predictable Cash Flow – Revenue and cash flow are the number one attraction to most purchasers, so a business with an established pattern of growth will generally bring a premium price. Recurring revenue streams are often valued higher than non-recurring revenue streams, since there is less risk that they will not continue after a transition. Buyers are willing to pay the highest amount when they perceive the cash flow is predictable and will increase into the future.
- Reliable Financial Information – When purchasing a business, a buyer will perform some level of financial due diligence, to ensure that reliable financial records support the revenue and profit claims of the seller. If the financial records are incorrect, unsupportable or incomplete, the buyer will most likely move on to the next opportunity.
- Customer Diversity – A broad customer base in which no single customer accounts for more than 5 or 10 percent of sales helps to insulate a company from the loss of any one account. It reduces the risk of reduced cash flow if one or more customers do not stay under the new ownership.
- Strength of Management Team – Buyers look for situations where management and key employees want to stay for the long term. If the company’s success relies on strong management and capable, well-trained employees, and not just the owner, the business should not be negatively impacted under new ownership, resulting in lower risk and a higher purchase price.
- Growth Potential – When an owner can describe realistic opportunities for growth that specifically show how cash flow and profit can increase after it is acquired, a higher value can be achieved. A documented strategic plan demonstrates the viability of the company’s future and may identify opportunities that a buyer had not considered.
- Operating Systems and Procedures – The establishment and documentation of standard business procedures and systems demonstrates that the business can be maintained profitably after the sale. These include the computerized and manual procedures used to generate revenue and control expenses, as well as methods used to track how customers are identified and managed, and how products or services are delivered.
- Facility and Equipment Condition – The business facilities and equipment should be well maintained to realize maximum value. Disorganized or poorly maintained facilities or equipment generate fear that capital investment may be required soon, and raise warning flags that other aspects of the business may be similarly disorganized. Optimally, the facilities and equipment should have the capacity to accommodate modest growth without the need for immediate investment.
- Goodwill – Goodwill attributable to the business, and not just to the owner, can significantly enhance the value of the business. Name recognition, customer awareness, history, ongoing operations and reputation are all part of business goodwill and can influence value. However, personal goodwill attributable to the business owner will generally have no value to a purchaser. Strategies can be identified and implemented to transition personal goodwill to business goodwill, so that it enhances value in the eyes of the purchaser.
- Barriers to Entry – Purchasers will pay a premium for businesses with features that provide a barrier to successful entry by competitors. Warren Buffet describes this as a “Business Moat”, surrounding the “Castle” that is your business. The more factors that widen the moat and hinder competitors from breaching the castle, the greater the value of the business.
- Product Diversity – A narrow product offering increases risk and reduces business value. A more diverse revenue mix lowers risk. Therefore, businesses with a healthy product mix, good gross profit diversification, or with products or services sold into multiple industries receive a higher perceived value from perspective purchasers.