What are the top drivers of value in a privately held company? Is it revenue, longevity, industry type? These certainly come into play but they don’t make my top 10.
I’ve sold over 170 businesses over the past 12 years and have conducted well over 1,000 valuations of small and medium size businesses. I’ve encountered very few business owners over the years who were well versed in the most important elements of what creates value in a company.
How many of the features listed below can you identify as attributes of your business?
10. REPUTATION: Perhaps not the most important item on this list, reputation remains a significant quality as it often affects the first impression of prospective buyers. It is reasonable to expect a buyer to Google your company within the first five minutes of their initial assessment. If the results are full of negative reviews, you may immediately lose interest.
9. BARRIER TO ENTRY: If your company is easy to replicate and there is a significant cost-benefit to a buyer simply starting from scratch, your company’s value could be negatively impacted. On the contrary, if you have something unique about your company such as a patent or proprietary software, your company likely has a significant barrier to entry, thus resulting in a higher value.
8. QUALITY OF BOOKS AND RECORDS: Having clean, well organized financials greatly improves your ability to sell your business for a top of market valuation. If you have a lot of “creative” write-offs, you will need to be able to provide supporting evidence of the adjustments. These adjustments (aka add-backs) should be limited to a degree as a more tedious due diligence process will likely limit your buyer pool and reduce the likelihood of a buyer being able to leverage with bank financing.
7. QUALITY OF EMPLOYEES: There is a fine balance between having all-star employees and creating a situation where one or more employees become so key to the operation that there is risk if they don’t transition with the company. Cross training your staff can help alleviate concerns of an employee becoming irreplaceable. Never create a situation where an employee is in such a leverage position that they can hold you hostage from selling your company.
6. CLIENT CONCENTRATION: What’s better…3 clients who generate $300,000 profit per year for your business or 15 clients generating the same amount? The answer depends on who you ask. Certainly 3 clients sounds easier to manage than 15 but if one of your 3 clients disappears, your business will tank. Most buyers will view a business as having a client concentration issue if one or more of your clients equates to greater than 10 – 15% of your overall revenue. Client concentration doesn’t necessarily impact the overall value of your business but will most certainly affect the terms of the purchase. i.e. A buyer will want to mitigate against risk by adding an earn-out component to the deal. An earn-out is simply a portion of the purchase price that is tied to future events post sale, such as client retention or maintaining certain performance metrics.
5. PROFITABILITY: Profit is king, right? There’s a reason it’s not number one on my list. Although most businesses are valued based on a multiple of net profit, the appropriate multiple is based largely on the qualities of the business as indicated in this list. The more of these traits your company possesses, the higher your company is likely to sell for.
4. VOLATILITY: Most businesses experience ebbs and flows but consistency is a valuable trait. If your company is highly affected by outside influences such as the overall strength of the economy, consumer spending trends, seasonality, etc., the unpredictability of future performance will have a negative impact on valuation. Even if you are coming off your best year in business, if the year over year performance is overwhelmingly better in the current year, buyers will remain cautious about the viability of maintaining such a level of success. The optimal scenario is three consecutive years of incremental growth.
3. BUYER POOL: Your company can check a lot of boxes on this list but if the buyer pool for your business is relatively small, these other factors may not save your valuation. i.e. If your company requires certain credentials that the general population of buyers do not possess, you will lack leverage for a substantial offer with a low level of demand.
2. SCALABILITY: One of the most important features of a company is its ability to scale. Retailers have the least appealing model when it comes to scalability. Yes, you can always open more stores but the success of location dependent businesses is certainly not bankable. Rather, a service based company may be well equipped to expand operations into other regions with less risk and more upside potential.
1. RELIANCE ON OWNER: Once again, if your business checks all of the other boxes, you may not even be able to sell your company if it is highly reliant on you as the owner. Here are some tips on making your business more turn-key:
- Avoid significant personal interactions with your clients to the point where they only want to work with you.
- Create written policies and procedures so that you and your employees can easily be replaced.
- Whenever possible, focus your energy on the big picture agenda for your company and less on putting out fires.
- If you are constantly putting out fires, learn to delegate better and reward those who demonstrate a capability of taking on more responsibilities such as scheduling, training, etc.
If you found this information to be helpful, I have a lot more tips to share with you on how you can create the ideal exit strategy for your company. The advice is free and I am always happy to provide free and confidential valuations. (858) 382-4974, firstname.lastname@example.org