“No one is more hated than he who speaks the truth.”
Plato
When business value owners think about its worth, they rarely do it objectively. Most do not know how to value their business from the perspective of a buyer.
If they do know valuation methods, they often apply entirely subjective criteria so that the result gives them the number they are looking for. Thinking like a buyer means detaching all emotion from the way you think about your business – and usually that means getting someone else to look at the value. Even then it’s hard not to “shoot the messenger” when the results come through and it’s not the news you are looking for.
Getting an objective valuation for your business from someone who looks at all the risk factors in your business is something any business owner should do as early as possible. And keep doing it on a regular basis to see how you are improving.
The value of your business is about more than just the numbers.
The four most important risk factors a buyer looks at in the first instance are:
- Over reliance on the business owner
- Concentration of revenue on a small number of customers
- Lack of financial reporting (or poor-quality financial information);
- The rhythm of revenue generation (recurring revenue)
Looking at these issues objectively, they make sense not just to a buyer but to a business owner. If the business can’t run without you, then you can never take a relaxing holiday or prolonged absence. What happens if you become ill or incapacitated? Or worse? If the entire customer base relies on the relationship the clients have with the business owner this poses a significant risk to the immediate and long-term revenue of the business. This is what a buyer is acquiring and investing in.
Without historic financial reporting the buyer finds it hard to see the real operational performance of the business. The robustness of the business financial reports give comfort to the buyers who are investing in a return on their investment. It’s easier to sell if you help the buyer see the value and not make him work for it. The harder a buyer must work to get to understand the numbers, the more nervous they get and the more risk they see.
One way of looking at your business is asking the question “Would I buy this for the amount of money I’m asking?” and secondly “Where would I get a return on the investment I’m making?” This is the first step into the buyer’s shoes.
The more risk the buyer sees in the business, the lower value they place on the investment – or they walk away before wasting more money on the due diligence process. Due diligence costs both parties in time, energy, and money. For the unprepared seller it also adds greater levels of anxiety and stress, especially if there is time pressure to sell because of circumstances.
The great advantage of addressing these 4 factors, whether you are planning to sell now or in the future, is that you are adding value to your business as you work through them. By removing the reliance of the business from being entirely on your shoulders, you’ll also find you have more time and better performance from your team. Win-Win!
Why are different valuation methods used?
There are many ways to value a business and each one has its benefits and weaknesses. Knowing which one is best for you puts you ahead of the competition
The most common methods used in professional M&A firms (including banking, private equity etc.) are:
- EBITDA (earnings) multiple
- Revenue multiple
- Discounted Cash Flow
- Precedent Transactions (consensus price based on other similar transactions)
A business with recurring revenues and high customer loyalty has a higher future value than one that has one-off purchases and must constantly source new customers, even if they both have the same EBITDA for the last 3 years. Thus, different valuation methods are used.
Understanding how your business is valued by potential buyers gives you a head start in the sale process because you can prepare your business accordingly. Valuing your business using a different valuation method to your buyers sets you on the wrong path, with unrealistic expectations. Knowing what buyers in your industry look for means you have insights that put you ahead of other sellers. Or it may even get you looking outside your industry and into other sectors for a buyer who is looking for a break into your industry sector or who operates in a complementary space.
I’m not going to go into the details of valuation methods here. That’s worthy of an entire book.
The truth is you shouldn’t have to worry about every aspect of the process. You’ve been busy building your business, not learning to become an M&A (mergers and acquisitions), legal and corporate finance specialist. Here I just want to eliminate some uncertainty and make sure you have the tools and knowledge to enable your business to thrive into the future.
Are you stuck in the day-to-day of your business with no time to plan for the future? A Professional Business Mentor is just the leverage you need to get out of the rut and flying. Discover how you can make your business worth more AND avoid leaving money on the table when you finally leave your business. Click here to contact Christine by email alternatively you can book a call with the Business Mentor of the Year 2020, author and speaker. Who helps business founders get their businesses exit ready so they can enjoy a happier, richer future. She saves them THOUSANDS and increases the value of their businesses by MILLIONS.
