Valuation

What Makes a Business Worth More?

By Troy Frank, Owner, Indiana Equity Brokers

Estimated read time: 6 min

The short answer: A business is worth more when a buyer can see steady profits, low risk, and a company that runs without the owner. The biggest business value drivers are recurring revenue, a diversified customer base, a real management team, clean financials, and consistent growth. Two businesses with the same earnings can sell for very different prices because of these factors. Most Main Street businesses sell for roughly 2 to 3.5 times their seller’s discretionary earnings, and the strongest value drivers are what move you to the top of that range.

Two owners walk into my office in the same month with the same number on their tax return. Both made about $500,000 in adjusted earnings last year. One sells for $1.4 million, and the other sells for nearly $1.8 million. Same earnings, very different price. The gap comes down to business value drivers, which are the things a buyer studies to judge how risky and how durable your profits really are.

You can’t always put an exact dollar figure on each one. But you can look at your business honestly and see where you stand. Below is the scorecard buyers use, what each driver does to your price, and where Indiana owners tend to leave money on the table.

The value-driver scorecard

Here’s a simplified version of what a buyer or appraiser weighs when they size up your company. Look at each row and decide, honestly, whether you sit on the low, medium, or high end.

The list could go on, because almost anything that affects risk affects value. But don’t just compare yourself to businesses in general. Compare yourself to the specific buyers and competitors in your market, because that’s the bar your sale price gets measured against.

The two drivers that move price the most

If you only fix two things before you sell, fix these. In my experience they swing the final price more than any other factors on the scorecard.

Customer concentration

Buyers get nervous when too much of your revenue comes from too few customers. The rule of thumb most buyers and appraisers use is straightforward. If your single largest customer is under 10 percent of revenue, you’re in healthy territory. Between 10 and 20 percent, a buyer gets cautious. Once one customer crosses 20 percent, and especially north of 30 percent, you’re in a high-risk zone, and the multiple usually gets compressed below the industry median.

The logic is simple. If losing one phone call could cut your revenue by a third, the buyer is buying that risk along with the business. Long-term contracts and high switching costs soften the blow, but the safest path is to spread your revenue across more accounts before you go to market.

Owner dependence

This is the one Indiana owners underestimate most. If the business only works because you’re the one answering the phones, holding the customer relationships, and making every decision, then a buyer isn’t purchasing a company. They’re purchasing a job that depends on you, and you’re the one person leaving. Key-person dependence on the owner compresses the multiple below the median for exactly that reason.

The flip side is real money. A business with a capable second-in-command, documented processes, and customer relationships spread across the team is far less risky to buy. De-risking owner dependence is one of the few moves that can meaningfully raise your multiple, and in some cases it can come close to doubling it. The earlier you build that bench, the more it’s worth at closing.

How business value drivers turn into a number

Main Street businesses generally sell in a range of about 2 to 3.5 times seller’s discretionary earnings, and larger lower-middle-market companies trade on a multiple of EBITDA. Where you land inside that range is the whole game. Strong, diversified, well-documented businesses earn the high end. Owner-dependent businesses with shaky books and one giant customer earn the low end, if they sell at all.

That’s why two companies with identical earnings can sell hundreds of thousands of dollars apart. The earnings tell a buyer what the business made last year. The value drivers tell a buyer how confident they can be that the profits will still be there next year, without you. Confidence is what buyers pay a premium for.

This is also why the timing matters. Most of these drivers can be improved, but not overnight. Diversifying a customer base, building a management layer, and cleaning up financials are projects that take quarters or years, not weeks. Owners who start a year or two ahead consistently sell for more, which is the heart of good exit planning.

What you can do before you sell

Start by getting an honest read on where you actually stand, ideally from someone who sells businesses for a living rather than from your own optimism. At Indiana Equity Brokers we give every owner a free, confidential business valuation before they sign anything, so you know your range and your weak spots up front.

From there, the highest-payoff projects are usually the same. Reduce your reliance on any single customer. Build and document a team that can run the day-to-day without you. Get your books clean enough that a buyer’s accountant won’t find surprises. Each of those directly attacks the risk a buyer is pricing in, and lowering that risk is what moves you up the multiple.

Frequently Asked Questions

What are the main value drivers of a business? The main value drivers are recurring or repeat revenue, a diversified customer base, consistent and growing profits, a management team that can run the business without the owner, clean financial records, and a healthy industry trend. Buyers study these to judge how risky your profits are. The stronger they look, the higher the multiple a buyer will pay.

How much is my business worth? Most Main Street businesses sell for roughly 2 to 3.5 times their seller’s discretionary earnings, and larger companies sell on a multiple of EBITDA. Where you land in that range depends on your value drivers, so two businesses with the same earnings can sell for very different prices. A confidential valuation from a broker is the most reliable way to pin down your number.

Does customer concentration lower the value of my business? Yes. When one customer makes up more than 20 percent of your revenue, and especially more than 30 percent, buyers treat it as a real risk and usually pay a lower multiple. Under 10 percent from any single customer is considered healthy. Spreading revenue across more accounts before you sell is one of the most reliable ways to protect your price.

How does owner dependence affect business value? A business that only runs because of the owner is harder and riskier to sell, so it earns a lower multiple. Buyers want a company that keeps performing after the owner leaves. Building a capable management team and documenting your processes reduces that risk and can meaningfully raise your valuation, sometimes close to doubling the multiple.

How can I increase the value of my business before selling? Focus on the business value drivers that lower a buyer’s risk. Diversify your customer base, build a management team that can operate without you, clean up your financial records, and show steady growth. Most of these take a year or more to improve, so the owners who plan their exit early are the ones who sell for the most.

The bottom line

Your earnings tell a buyer what your business made. Your value drivers tell them how safe those earnings are going forward, and that’s what decides whether you sell at the top or the bottom of the range. The good news is that most of these drivers are within your control if you start early enough.

If you want an honest assessment of where your business stands and what it could be worth, a confidential conversation costs nothing. Troy Frank and the team at Indiana Equity Brokers have closed more than 878 deals for Indiana business owners, with no upfront fees and a free valuation to get started. You can reach Troy at troy@indianaequitybrokers.com

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Unraveling the Complex Realities of Valuations

The Art and Science of Business Valuation: Key Factors to Consider

Determining an accurate business valuation is a complex process that requires careful consideration of multiple factors. At Indiana Equity Brokers, we understand the intricacies involved in valuing a company and the impact it has on mergers and acquisitions (M&A) transactions.

Ownership Structure and Employee Stock Ownership Plans (ESOPs)

The ownership structure of a company plays a crucial role in its valuation. Companies with employee ownership, such as those with Employee Stock Ownership Plans (ESOPs), may face unique valuation challenges. While ESOPs can affect marketability, they also offer potential benefits that should be carefully evaluated during the valuation process.

Intellectual Property and Intangible Assets

Intellectual property (IP) is a vital component of many businesses’ value. Assessing the worth of patents, trademarks, and copyrights requires specialized expertise. At Indiana Equity Brokers, we have experience in valuing these intangible assets to provide a comprehensive assessment of a company’s worth.

Technological Advancements and Industry Disruptions

In today’s rapidly evolving business landscape, technological advancements can significantly impact a company’s valuation. Businesses must stay ahead of industry disruptions to maintain their value. Our team at Indiana Equity Brokers analyzes market trends and technological developments to provide accurate valuations that account for potential future challenges.

Product Diversity and Customer Base

Companies with diverse product portfolios and broad customer bases often command higher valuations. We assess the range of products and services offered by a business, as well as its customer concentration, to determine a fair and accurate valuation.

To learn more about the factors affecting business valuations, visit the International Business Brokers Association (IBBA) website.

The Importance of Professional Guidance

Valuing a business requires a delicate balance of analytical skills and industry knowledge. At Indiana Equity Brokers, our experienced M&A advisors can help navigate the complexities of business valuation, ensuring a thorough and accurate assessment for your company.

The Complexities of Business Valuations

 

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How Does Your Business Compare?

When considering the value of your company, there are basic value drivers. While it is difficult to place a specific value on them, one can take a look and make a “ballpark” judgment on each. How does your company look?

Value Driver	Low	Medium	High
Business Type	Little Demand	Some Demand	High Demand
Business Growth	Low	Steady	High & Steady
Market Share	Small	Steady Growth	Large & Growing
Profits	Unsteady	Consistent	Good & Steady
Management	Under Staffed	Okay	Above Average
Financials	Compiled	Reviewed	Audited
Customer Base	Not Steady	Fairly Steady	Wide & Growing
Litigation	Some	Occasionally	None in Years
Sales	No Growth	Some Growth	Good Growth
Industry Trend	Okay	Some Growth	Good Growth

The possible value drivers are almost endless, but a close look at the ones above should give you some idea of where your business stands. Don’t just compare against businesses in general, but specifically consider the competition.
As part of your overall exit strategy, what can you do to improve your company?

© Copyright 2015 Business Brokerage Press, Inc.

Photo Credit: kconnors via morgueFile

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Valuing the Business: Some Difficult Issues

Business valuations are almost always difficult and often complex. A valuation is also frequently subject to the judgment of the person conducting it. In addition, the person conducting the valuation must assume that the information furnished to him or her is accurate.

Here are some issues that must be considered when arriving at a value for the business:

Product Diversity – Firms with just a single product or service are subject to a much greater risk than multiproduct firms.

Customer Concentration – Many small companies have just one or two major customers or clients; losing one would be a major issue.

Intangible Assets – Patents, trademarks and copyrights can be important assets, but are very difficult to value.

Critical Supply Sources – If a firm uses just a single supplier to obtain a low-cost competitive edge, that competitive edge is more subject to change; or if the supplier is in a foreign country, the supply is more at risk for delivery interruption.

ESOP Ownership – A company owned by employees, either completely or partially, requires a vote by the employees. This can restrict marketability and, therefore, the value.

Company/Industry Life Cycle – A retail/repair typewriter business is an obvious example, but many consumer product firms fall into this category.

Other issues that can impact the value of a company would include inventory that is dated or not saleable, reliance on short contracts, work-in-progress, and any third-party or franchise approvals necessary to sell the company.

© Copyright 2015 Business Brokerage Press, Inc.

Photo Credit: DuBoix via morgueFile

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Two Similar Companies ~ Big Difference in Value

Consider two different companies in virtually the same industry. Both companies have an EBITDA of $6 million – but, they have very different valuations. One is valued at five times EBITDA, pricing it at $30 million. The other is valued at seven times EBITDA, making it $42 million. What’s the difference?

One can look at the usual checklist for the answer, such as:

• The Market
• Management/Employees
• Uniqueness/Proprietary
• Systems/Controls
• Revenue Size
• Profitability
• Regional/Global Distribution
• Capital Equipment Requirements
• Intangibles (brand/patents/etc.)
• Growth Rate

There is the key, at the very end of the checklist – the growth rate. This value driver is a major consideration when buyers are considering value. For example, the seven times EBITDA company has a growth rate of 50 percent, while the five times EBITDA company has a growth rate of only 12 percent. In order to arrive at the real growth story, some important questions need to be answered. For example:

• Are the company’s projections believable?
• Where is the growth coming from?
• What services/products are creating the growth?
• Where are the customers coming from to support the projected growth – and why?
• Are there long-term contracts in place?
• How reliable are the contracts/orders?

The difference in value usually lies somewhere in the company’s growth rate!

© Copyright 2015 Business Brokerage Press, Inc.

Photo Credit: jeltovski via morgueFile

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