Selling Your Small Business: Four Variables Can Boost SMB Valuations
If you’re thinking about selling your business in 2018-2019, the time is right.
Why? First, the value of companies has never been higher. Buyers are paying premiums for well-run companies. Second, we are on the edge of an upward economic cycle, which is the best moment to sell your business. As of the time of this writing, the Dow Jones Industrial Average reached an all-time high of more than 26,000. Third, low-interest rates make it possible for buyers to lower their cost of capital when acquiring companies. Fourth, the unprecedented abundance of capital available for investments has never been higher. And finally, due to increased confidence in the economy, a record number of investors are looking for potential acquisitions.
However, receiving top dollar for your business is tied to how buyers perceive their financial risks and rewards. The more future potential reward a buyer perceives, the more a buyer is willing to pay for your business. The strength and quality of your key business drivers are critical to receiving the highest possible price.
Four Variables that Drive Business Valuations
There are 10 to 12 major business factors that drive value, but they vary by industry. Nevertheless, four of these transcend almost all other drivers regardless of the industry. They are:
- strong recurring and diversified revenue streams, profits, margins and scalability;
- strong strategic business plans driving revenues from a diversified and loyal customer base;
- strong expected future cash flow and EBITDA (earnings before interest taxes depreciation and amortization) growth; and
- strong management bench strength and operating systems.
Focusing on these four business drivers can position you to maximize your company’s purchase price.
The No. 1 business driver among buyers is a history of increasing revenues and profits year over year for the past three to five years. Remember, buyers, buy businesses to make money. While they will examine your past financials, operations, and other due-diligence areas, they are really buying future expectations of revenues and earnings.
A second major business driver is a strategic business plan that is demonstrating strong organic growth (sales from existing and new customers), and inorganic growth (acquisition plans to gain share of market and expanded sales if any). The plan must show strong competitive advantage in high-growth industries. If the products/services can be sold in multiple industries, so much the better. The value of your company will be even higher than those companies that serve only one industry.
A third major business driver is expected future cash flow. This includes a trio of key performance areas: expected EBITDA performance; expected working capital investment requirements, and expected fixed-asset investment requirements (also known as capital expenditures, or Cap Ex).
The higher your expected future EBITDA, the higher your company value – all else being equal. To drive expected EBITDA higher, be certain your strategic business plan is demonstrating sustained sales growth, market share gains, consistent improvement in EBITDA and gross margins. The plan should clearly articulate how you are generating both your organic and inorganic sales.
Surprisingly, your existing debt load is not necessarily meaningful in these expectations, as buyers can change the capital structure as part of the transaction.
Next, the lower your expected Cap Ex and working capital investment requirements (often ballparked as receivables plus inventory minus accounts payable) are, the higher your valuation. Ways to decrease your working capital requirements include cutting your average accounts receivables days outstanding, cleaning up bad debts, increasing your working capital turns, removing obsolete inventory and not paying vendors faster than necessary to earn your discounts. In other words, don’t pay your vendors faster than necessary just because you can.
Finally, the lower expected working capital investment means higher expected cash flow. To lower expected Cap Ex, keep your facility, equipment and rolling stock well-maintained and invest in fixed assets prudently. Palatial facilities do not translate into a higher value for your business unless they also translate into higher future expected cash flow.
A fourth major business driver that lowers risk includes having a strong management team in place (bench strength) and strong operating systems. The more your business revolves around only you or another “key man/women,” the greater the perceived risk among buyers. Therefore, strange as it may sound, owners should strive to work themselves out of a job. A corollary to a strong management team is a quality employee base with low turnover. Both of these infer a strong culture and a stable labor force for future growth.
I recommend to clients that they obtain a detailed business assessment (audit) and analysis from a business consultant so they can identify their business’s strengths and weaknesses. The recommendations from the business assessment should identify which business drivers to improve so owners can obtain the highest price paid by a potential buyer.