HOW TO INCREASE YOUR BUSINESS VALUATION BEFORE YOU SELL
Selling Your Business? You Could be Leaving a Lot of Money on the Table
If you’re selling a small business, knowing what your business is worth is critical. But what do you do if your business valuation is not what you expected?
Once the numbers have been crunched properly, many business owners find their market valuation is less than they’d imagined. If that’s the case, certain steps can be taken to boost your business’ appeal before placing it on the market.
Your business may represent the culmination of your life’s work and is usually your primary source of income and wealth. You’ve sacrificed blood, sweat, tears, life savings & years building your business. It would be fair to say you want top dollar for all of your hard work and effort.
A common question is, “How do I sell my business?” A better question should be, “How do I increase the value of my business?”
Why? Because building a solid exit strategy can take several years. If you are a business owner, who want to cash out for maximum value, you should ideally start planning for sale 3-5 years before you wish to exit.
Before we discuss how to increase your business value, let’s cover the basics of a business valuation.
What’s a business valuation?
A business valuation assesses the economic value of your business. It’s basically an independent appraisal of what your business is worth now and how much you could potentially sell it for.
Generally, the valuation process analyses all aspects of the business, including the company’s management structure, financial situation, future earnings, uniqueness, sustainability, vulnerabilities, and the market value of its business assets.
Why business valuation is important
How do you place a price for the time and effort you’ve sacrificed making your successful business?
Because of your emotional attachment to this, it can be difficult to objectively assess how much your business is really worth. Your idea is often very different to a fair market price.
This is where a business valuation calculation, ideally handled by an independent third-party expert, plays a role in determining your business value.
After a valuation, you should have a good understanding of the potential liabilities and opportunities that you may not have been aware of. This information provides you with insightful knowledge to make educated decisions to improve the value of your business before you sell.
Common business valuation methods?
Choosing the correct valuation method and the right business valuation specialist matters.
Choosing correctly could mean the difference between hundreds of thousands of dollars.
There are several methods used to estimate the potential value of a business. Common approaches to a business valuation generally include a review of financial statements, the demand for the business in the industry and a comparison to similar businesses in your niche.
These business valuation methods used vary among independent evaluators, brokers and accountants.
Profit multiple valuation method
To use the profit multiple valuation method, you need two figures to work with: one is the average net profit for the past three financial years, and the other is an industry-standard multiplier that is commonly applied to businesses in the same industry. We then multiply these two figures to get your business valuation estimate.
The multiplier for small to midsized businesses will generally fall between 1 and 3. For larger‚ more established organisations‚ the multiplier can be 4 or higher.
Multipliers are awarded for many different industry factors. Common examples are cash flow, location, years in business, competition, uniqueness and robustness of concept, profitability, sustainability, future growth opportunities, long term contracts, etc.
Usually, the more dependant the business is on the owner for survival and day to day operations, and the less established the business is‚ the lower the multiplier. The more established and systemised the business is, the bigger the multiplier.
Here is a business valuation estimate formula:
Business Valuation = Net Profit (NP) x Multiplier
$500 000 = $200 000 x 2.5 multiplier
In the example above, if a business’ average net profit for the past 3 years is $200k and the business is awarded a multiplier of 2.5, the valuation estimate would be $500k.
Discounted cash flow method
Discounted Cash Flow (DCF) is a method of estimating what a business is worth today by using projected cash flows. It uses projections of the business future cash flows and then adjusts them to meet current market value. It tells potential buyers how much money they can spend on purchasing the business right now to get the desired return in the future.
The DCF method is often used when a business is expected to have a relatively stable level of margins and growth in the future.
The business asset valuation method
Your business’s assets include tangible assets and intangible assets. This method uses the market value of these assets to determine your business’s worth. This method takes into consideration all the cash, equipment, inventory, real estate, stocks, trademarks, intellectual property and customer relationships to calculate the asset valuation for your business.
This valuation method is commonly used by businesses that are liquidating.
How to increase your business valuation?
1 – Give yourself plenty of time
If you make the decision to go to market and then begin your business exit planning, you could be seriously shortchanging yourself. This delay could cost you hundreds of thousands of dollars.
The process of selling your business takes time. This time allows you to execute steps to improve your business valuation. The difference in your business value could be hundreds of thousands, if not millions, of dollars.
Expect to spend a minimum of six months to a year preparing to sell your business.
Bringing in an outside advisor or consultant who can conduct an objective review of the business and its financial statements can be extremely valuable in the process. A knowledgeable third party can provide a fresh perspective and help you see areas of concern you may otherwise have missed. They can also offer the support and insights you need to navigate the sale’s process when the time comes.
2 – Diversify your revenue & establish recurring revenue streams
Everyone knows that it’s risky to put all your eggs in one basket. The same goes for business revenue streams.
Buyers want to see potential revenue diversity, not just your total dollar amount each month.
The more ways you can earn money, the more confident the buyer becomes in the businesses’ sustainability and ability to grow.
You can either focus on getting new customer groups or adding products and services. But before doing so, make sure that you have a full understanding of your customer base and what products they want to buy. Businesses that have a higher level of understanding of their customers and what they are willing to pay for will be able to create new revenue opportunities faster and easier than businesses that have little understanding of their customers’ shopping profiles.
A business with recurring revenue streams will attract a higher multiplier and therefore have a higher valuation. These businesses are more attractive and less risky because the new owners are guaranteed revenue from day one after the sale.
3 – Increase profitability
It makes sense that a potential buyer is willing to pay more for a business that profits are increasing year on year compared to one that is struggling and producing diminishing returns.
Not all businesses generate profits when the owner decides to sell. Obviously, this affects the business valuation dramatically.
If you have the luxury of time, see if you can make changes to improve your business profitability. The rewards will be well worth the effort.
Start by seeing any untapped markets that you haven’t tried and any opportunities to improve your operations and reduce overheads.
If your business is generating profits, is there an opportunity to improve the bottom line?
4 – Streamline your operations
Efficient and productive businesses tend to make more profits. Therefore, review your business operations.
The aim is to increase productivity and revenue while lowering the cost of operation without sacrificing quality. You want higher earnings with lower overheads. Basically, you want to show a potential buyer how to do more with less. A streamlined business with robust systems and processes will attract a higher multiplier than one that is disorganised and heavily reliant on the owner to perform most tasks.
5 – Set your business apart from the competition
How unique is your concept?
Buyers love unique concepts – that are proven. The more unique your concept is, the greater the value. If your unique concept is proven and can be scaled without blowing out your cost base, your business valuation jumps through the roof.
Remember when you are selling your business, you will also have competition. Today’s business landscape is more competitive than ever before. Potential buyers are not only looking at your business. They are looking at other businesses in the industry for sale and will compare them to yours to see which opportunity is most favourable to them.
Your business, therefore, needs to stand out from the crowd. Your uniqueness is a great way to attract potential buyers to you, not the competition.
6 – Paint the picture and showcase the long term
When potential buyers choose a business to buy, they are looking for an opportunity to maximise their return in the quickest amount of time, with the least risk.
These potential buyers place themselves in the shoes of the current owner and try to visualise the growth opportunities, the risks and the potential future earnings of the business.
You, as the seller, can help the potential buyers visualise the opportunity by painting a picture for them.
Buyers are willing to pay a higher price if there’s a clear road map to achieving higher returns. If you can show buyers what they might expect in return over the next three to five years, you can significantly increase your multipliers.
These numbers and predictions can’t be fabricated, however. Your forecasts and projections need to be accurately extrapolated from your current financials.
Your goal when selling your business is not to make it perfect. Your goal is to ensure its future earning potential is showcased as more valuable than competitor businesses for sale.
This attracts more potential buyers, improves your valuation, maximises your sell price and shortens your time frame to sell.
This article covers just a few steps to help you increase your business valuation. There are, in fact, 12 steps to maximising your valuation.
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