Viewing your Business from a Buyer’s Perspective
I often get asked about “What are the key elements that a business owner needs to undertake to increase the value of the business?”
This is important since because when we start a business, our key financial objectives are:
- To generate a regular income, which pays for our daily requirements
- To build wealth in our business, which funds our dream lifestyle and retirement.
Unfortunately we can only unlock the wealth accumulated in our business when we sell the business. And as 80% of businesses do not sell, business owners often have little choice but to walk away from their businesses.
It is important to understand that to build wealth in a business, business owners need to change their perspective to that of the buyer by asking the following question.
How can I structure and nurture my business in order to make it attractive to potential buyers?
A potential buyer ‘s paramount consideration is to evaluate the likelihood that the business will continue to maintain it’s current profitability under new ownership. In other words how “risky” is the business if they buy it or “how sustainable is the business performance?”.
The Drivers of Business Valuations
There are several different methods of valuing a business, and in this review I will use the EBIT Multiple Valuation method as this shows clearly the upside of adopting a buyer’s perspective.
In the EBIT Multiple Valuation method, the Selling Price for the business is derived by multiplying the ongoing business Profit by an appropriate Valuation Multiple.
Selling Price = Profit times Valuation Multiple.
For example, a business that generates $500,000 Profit per year and has a Valuation Multiple of 2 should achieve a Selling Price of $1million.
$1,000,000 = $500,000 X 2
The drivers of Profit are: revenue, costs and growth opportunities etc. In most cases these are already the key focus of business owners. In contrast the drivers of Valuation Multiple are risk and return, and these are not always top of mind.
For example, a business with high risk and limited potential will have a low multiple while a business with low risk and high potential will have a relatively higher valuation multiple.
Reducing Risk does pay off!!
Our analysis from investigations reveal that a business that is totally reliant on a business owner to win customers or manage daily tasks is highly risky and normally generates 1 to 2 times Valuation Multiple. In contrast a business that has developed systems and well understood accountabilities has much less purchasing risk and can generate 3 to 4 times Valuation Multiple.
A key result of this is that it is often easier to drive up business value by reducing the purchasing risk for potential buyers than by improving the profit. As the potential buyers become more confident in generating equivalent profit after they buy the business, the higher the multiple that they are prepared to pay.
Optimising your Business Value
The challenge for many owners is that their business is often not prepared when they need to depart, and this results in a loss of their business wealth. To address this, process of optimising a business for sale needs to start a few years in advance of your planned exit.
In my experience, the following 7 key questions should be addressed in your Business Optimisation Process. When you can answer positively to these questions, then your business is well placed to attract strong results as you have attended to both the profit and risk drivers that propel your selling price.
- Do your employees understand your business vision and how it supports your business strategy?
- Is the business currently profitable with a history of proven results?
- Does your business have strong growth prospects and is the management team implementing strategies to realise this potential?
- Does your business have goals and metrics in place to measure progress and does it undertake corrective action when required?
- Does the business rely heavily on a few key individuals and are they committed to the business for the medium term?
- Are the internal processes well documented, effective and sustainable?
- Are there strong governance and compliance policies in place?
In summary to unlock your business wealth, you need to take the following actions.
- Take time to view your business from the perspective of a buyer and gain new insights.
- As well as focusing on drivers that increase profit, you need to address business risk issues that could make your business unattractive to potential buyers.
- A business sale can be overwhelming and complex, so consider the value of hiring business professionals to assist you.
This blog is brought to you by Rob Jagger.