How is Business Value Determined?

I consider myself blessed to work with successful entrepreneurs. I love to hear “the story”: How they started in a spare room or a garage with little or no money, grinding it out 80-90 hours a week. Now, after several decades, they have a very nice business. They are all extremely competent and confident in their field. When it’s time to position the business to sell and maximize the benefit of all those years of focus and commitment, that is not their area of expertise. They realize that there are times that you need a professional. Advising business owners on the sale of their businesses is what we do.

One of the first questions we get is, what is my business worth? We can help with that. We also have professional partners who can advise you on different ways to structure the deal and the tax consequences of each.

How Is Your Business Valued?

Businesses are valued by a multiple of the cash flow, seller’s discretionary earnings, or EBITDA. This multiple can be anywhere from 1X to 10X and sometimes even higher, depending on the industry and the size of the cash flow. However, companies in the same industry can sell for dramatically different multiples, for the reasons you will see below.

What can you do to increase the value of your business?

1. Sales must be increasing year over year. Businesses with a decrease in sales will most likely be sold at a deep discount.
2. Re-Occurring revenue is king. If all of your business is project based, the number of buyers interested will be less and the multiple will likely be lower.
3. Does your business have patents, a difficult barrier to entry, or some other proprietary aspect that adds value?
4. Gross profit well above average for your industry. Have you developed your business in a way that allows you to operate at a much greater gross profit than your competitors through developing a niche, specialty, or a brand identity?
5. Are you the business? Are you the contact for the customers and suppliers? Do your employees come to you with all issues? If you can’t leave the business for 30 days without fear of a disaster, you may have a business, but it’s also a job. Put people in place who have the power to make decisions. The business must stand on its own. The more you are in the background with a strong team in place out front, the more attractive your business will be.
6. Customer concentration: Do you have 1 customer that makes up a large part of your sales or maybe 2-3 customers that account for 50% or more? A buyer and the bank will find this to be a concern as the loss of 1 customer could impact the bottom line greatly.
7. Supplier Concentration: Same as above. If your business is dependent on only a few suppliers, this creates an issue.
8. Clean books are a necessity. Eliminate unnecessary personal expenses. Some owners live out of their business, making it difficult to determine an accurate cash flow number. Remember, all businesses are sold at a multiple of cash flow.
9. Operations manual: Are all of your business procedures documented, from receiving an order until the order is filled? Are all of your personnel policies documented, etc.?
10. Management team In place: Do you have a strong management team in place to operate the business in your absence? Do you have a succession plan in place? That is, have you identified people in your business who have the capacity to do more? Do you have a plan in place to provide mentoring, training, etc., to grow these people into positions with more responsibility?
11. If you own a retail business or a business where your customers visit, how’s the curb appeal? When was the last time you remodeled? Buyers will be looking at your place of business with fresh eyes. Are the outside and inside up to date, modern, and appealing?
12. If you have any excess equipment or inventory not necessary to the operation of the business, clear it out. A buyer will not pay full value, if any, for the excess. Sell it now while you can take a little more time to get a better price.

Of course, there are other factors that can affect the value of your business, but these are the most common that we encounter.

So, how do you maintain a level of operation for your business that will get you maximum value when it’s time to sell? Contact us for a free consultation. We can help.