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What drives the value of your business?

One of my responsibilities in a former role was to attend industry-based conferences and because I was aware of many of the business sales taking place in those industries, I was frequently asked by business owners attending the conferences this question or some close variation – what are businesses selling for these days?


A seemingly simple question but one that I found difficult to answer, not because of a lack of data, but because the enquirer wanted a simple response to their direct question – businesses are selling for a profit multiple of X or Y% of revenue generated for example – but those statistics are the result of other considerations and negotiations. The reality of business value and business transactions is not that simple and always requires context.


As a business owner, consider these questions and your answer to each:

  • What factors do buyers consider when assessing a business like yours?

  • What are you referencing to assess the value of your business – recent transactions with detailed knowledge of the deal or dated information with little context?

  • What’s the gap between the current value of your business and the sale’s price you’d like to achieve to fund your next career or retirement?

  • What plans do you have to improve these factors over time?

In my experience, there are three broad factors that impact a business value: return, risk and transaction factors, which I’ve explained in more detail below:


Return:


Profitability is a key driver of the worth of your business, but sound profitability at a point in time isn’t always enough to optimise value. Buyers prefer positive trends such as growing revenues and profits and consistency in margins over recent years rather than volatility in results or a decline in performance.


The fundamentals of your business underlying your financial results are important as well – the size and nature of your client base and the systems and processes surrounding critical aspects of your business such as marketing & sales factor into buyer’s consideration.


Some vendors will promote the potential for improvement in their business as benefit for a buyer, particularly where they are lagging an industry benchmark, but in my experience, buyers won’t pay for potential if it’s their job to deliver into it as they see it as their upside not the vendors.


Risk:


Buyers want to be assured that the return being generated by your business will continue in the future and preferably grow. A well-organised business with engaged, accountable employees who are guided and driven by clear policies will attract buyers.


The attractiveness of the industry you operate in will typically impact the profit multiple applied to the returns your business generates – growth industries attract higher multiples as an example – but it’s important to understand the range of multiples applied to businesses like yours and the reasons for multiples paid at the upper versus the lower end.


Why you’re selling is an important consideration for buyers – retiring, looking to spend more time with family or keen to see the business grow under new owners are all reasonable responses. Taking some time off and looking to get back in to something on the fringe of your current industry isn’t.


Similarly, how reliant the business is upon owners is paramount in buyer’s minds. If you can’t take more than a week’s leave without the business needing to check in with you, you have work to do. If not addressed prior, expect a requirement for you to continue with the business for a designated period and/or a lower profit multiple being applied due to the heightened risk.


Negotiated terms, such as restraint of trade and retention sums, can be a way to provide comfort to a buyer around specific risks.


Transaction Factors:


A buyer’s experience with you as a vendor may impact value. Buyer’s will typically conduct some sort of due diligence to assess the above factors, but primarily the reason is to assess and preferably lower risk. Your preparedness to answer questions and requests for information will in my experience impact the enthusiasm of buyers.


The learning is that business value is not static and can be improved materially through planning and disciplined execution over time, with sufficient time to make changes and improvements to your business of critical importance. Implementing a management succession plan, establishing process and systems around operations and growing profitability all takes time.


If you’d like to discuss this topic further, please contact our Principal at cam@righthandadvisors.com.au.

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