Is Your Business Sellable?
Most company owners probably don’t want to sell their businesses right now, but they want to know that they could. So what are the factors that contribute to making a business sellable?
The most important factor is the amount of revenue along with the past and expected profitability.
A buyer, especially one who is financially astute, sees buying a business as paying today for a stream of profits in the future, which is why companies are generally bought and sold using a multiple of EBITDA earnings.
Focusing On Your Multiple …
But focusing on your multiple is a bit like a hypertensive person focusing on their blood pressure scores. To really understand the number and to move it up or down, you have to understand the calculations.
Buyers acquiring a company will usually do some calculations to determine what they are willing to pay today for the rights to your businesses future profits. We all make similar calculations in other areas.
To see how this works in selling your business, imagine you have a company that is expected to generate $1,000,000 in EBITDA profit next year. Buyers looking for a 15% return per year on their money would be willing to pay $869,565 for that one year profit stream.
When Valuing A Business …
But, as we know, the world isn’t that simple. When valuing a business, buyers not only look at one year’s profitability, but all of the expected profits in the foreseeable future. For every year into the future the buyer must wait to get their profits, they will “discount” the future profit you are projecting by the rate of return they expect. This is known as the “present value” calculation.
The price an investor is willing to pay for an asset relates to how risky they perceive the future stream of profits to be. The riskier the investment, the higher the return the investor will want.
Today’s potential buyers or investors can put their money into relatively safe bonds and get a few percentage points of return. They can buy a balanced portfolio of of large company stocks and get a significantly larger return over time.
When buying a relatively risky business, buyers expect a much higher return on their money. That same business that is projected to generate the $1,000,000 profit per year over the next 10 years, is worth less when the buyer projects a 25 or 30% return due to the risk.
Size Matters …
As in other endeavors, when selling a business; size matters. There is a perception among buyers that small companies are riskier that large ones. This is because it is generally understood that large businesses are more substantial and stable because they have found a way to grow beyond the efforts of just the owners and are therefore less reliant on the owners themselves.
But, you say to yourself, my business is worth more than just the stream of profits. We’ve built our company with a unique market position; we have the best people in our field; our customer list is full of premier customers and we have the best technology in our market. Certainly those things matter to the “strategic” buyer that is looking to gain market share.
Strategic Factors vs. Financial Factors …
Sometimes strategic factors do outweigh the financial factors. Revitalization Partners was recently asked to assist a potential buyer with the purchase of a business to which his company was one of the largest suppliers. He felt that by vertically integrating the business, the combination could be very profitable.
As we helped him evaluate the business and locate the financing, we learned that the seller had received an offer that was out of proportion to the financial performance of the business. The buyer, by this purchase, would monopolize their industry and that monopoly was more valuable to him, over the long run, than the financial performance of the business.
But, as a seller, what if you’re not in that position? What about those other strategic factors?
People are worth something only if they are very hard to replace and guaranteed to stay. While many business owners see their people as a strategic asset, a buyer may see them as hardly irreplaceable.
Value Of A Client List …
A client list is valuable only to the extent that the cost to acquire those clients is prohibitive. While good sales resources are not inexpensive, if your relationship with your clients can be disrupted by a good sales effort, then the client relationships are not strategic.
What is valuable in client relationships are long term contracts and/or the recurring revenue streams from those clients. A buyer knows that in a recurring business relationship, customers and clients are reluctant to change and they can model the future revenue and profits they can expect from the relationships.
The Way To Success …
The way to success in selling your business is to make the future as clear as possible for the buyer. By putting a focus on recurring revenue, profitability and, where possible, longer term contracts, you can maximize the return on your investment in your business.