A Formula For Success: How To Grow The Value Of Your Business
As a business owner, once you’ve decided you’re going to sell your business, it’s natural to then turn your attention towards growing its value.
“I want to grow my business by 20%, and turn my $1-million company into a $1.2-million company by next year.”
Sound familiar? Increasing your top line certainly grows value, but don’t stop there. There are other areas to which you can turn your attention when trying to attract buyers for your business.
Calculating Your Business Value
Businesses are typically sold for a price determined by the following, simple formula:
$ TIMES M = SALE PRICE
$ is the “profit” (represented by EBITDA: earnings before income tax, depreciation and amortization) earned by the business in the years prior to sale (typically three).
M, the “multiple,” represents the number of years a prospective buyer expects to operate the business before earning back their investment.
To determine M, a prospective buyer will perform “Due Diligence,” and investigate various aspects of the company, including, but not limited to, finances, personnel and market trends.
M is the leverage factor for increasing the sale value of your business.
For example, if you increase the sustainability of your company by bolstering its internal structure, you may increase the sale value significantly rather than growing revenue and or profits alone.
Think about that $1 million company. A buyer has done due diligence and determined that they’ll confidently commit to investing three years of ownership and operation before they’ve “recovered” their investment. They offer to buy it for $3 million.
If our business owner succeeds growing the topline by 20% before he sells it, he increases the sale value of that company to $3.6 million.
2 MILLION (3 YEARS, i.e. M) = $3.6 MILLION SALE VALUE.
But What If We Increase M?
Instead of focusing on the topline, our owner takes a year to educate and develop his management team, making sure they could run the business without him. He standardizes the operational and decision-making processes. He travels and networks to source new accounts and diversify his customer base.
While these things may have cost him money, his investment makes it easier for a prospective buyer to step in, and keep earning that $1-million or more after he’s gone. A buyer, attracted to the stability and robust internal structure of this business, might be more likely to “buy in” for 5 years instead of 3 years. The sale value is suddenly significantly greater – even though the top line hasn’t changed at all.
$1 MILLION (5 YEARS) = $5 MILLION
How Do We Increase M?
A friend and fellow Vistage member, Patrick Ungashick of White Horse Advisors, is an expert on business exit planning. Patrick defines “7 Areas of Transferrable Value,” a concrete list that clearly defines factors to examine during a Due Diligence process and determine M in the sale equation.
Patrick’s list includes:
- Decision-making capabilities of the management team
- Owner independency, i.e. the business can effectively operate without the owner
- Effective management systems and controls
- A compelling business model/plan
- Customer diversification
- Intellectual property/value
Whether planning to sell a business in the near or long-term, you should consider the ways in which your company is “valuable.” By increasing the “Transferrable Value” of your business, you may realize a significantly greater return on a sale than by focusing on the top, or bottom, line alone.