Placing a value on a business is one of the first steps that we complete at Indiana Equity Brokers. Establishing an accurate market value is paramount to a successful transaction. The actual valuation can be a complicated and intricate process.
Of course, the higher revenue and profits a company makes usually translates into a higher selling price. However, there are real-world factors that some businesses have that allow them to sell for a premium.
Here are the main factors that can lead to a business pulling in an extraordinary price at sale:
1. Avoid having a few customers account for large concentrations of revenue
Having 2-3 large customers that make up at least 50% of annual sales will concern a potential buyer because losing one or more of those customers will diminish a large portion of their investment. A buyer does not know what owner/customer relationships exist, therefore, it will be hard for them to justify compensating an owner for a large portion of the revenue stream that may disappear. While there are always exceptions, in general, maintaining a diverse customer base is considered less risky, and in turn, more valuable to a buyer.
2. Change the philosophy from minimizing taxes to maximizing cash flow
Many owners operate their business with the premise of minimizing taxes, which may constrict the amount of cash available to the owner. When preparing a company for sale, it is important to focus on maximizing overall cash flow rather than managing the costs to minimize a tax liability. One of the most important components in the valuation of a company is the cash flow available to the owner. The cardinal rule for a buyer when determining the value of a company is: the more cash available for distribution, the more the business is worth.
3. Differentiate the business/find a niche market
The ability to differentiate your business or find a niche market results in opportunities for higher profitability and increased cash flow while diversifying your customer base, all of which increase the value of your business. Additionally, differentiating your business showcases your company’s unique capabilities to a potential purchaser which adds value from their perspective.
4. Build a competent management team
There are different types of buyers who may be interested in your company. Some will be looking to purchase a business for personal employment and want to be involved in the day to day management of the company. A strong management team will help the new owner learn what has made your company successful as they transition themselves into their new role as the owner. The other type of buyer is the passive investor. To this buyer, a purchase is solely for cash flow (investment) purposes and wants nothing to do with the daily operations. A management team capable of operating the business without their involvement is a less risky investment and considered more valuable to the buyer.
5. Produce credible financial statements
Annually producing reliable financial statements makes a big impact on potential buyers. It is important to remember that the value of the company will be less if the buyer doesn’t have faith in the financial information provided. Obtaining reviewed or audited statements is a truer picture of the company’s financial condition making the investment less risky.
6. Be consistent. Steadily increase sales and profits
Although every industry is cyclical, buyers desire companies that have consistent and steady increases in sales and profits from year to year. Additionally, when valuing a company, the most recent few years are generally given the most consideration when predicting future earnings. In other words, if sales and profits have been increasing each year, the most profitable years will be used to determine the value.
Planning early and following these few simple steps, will thoroughly prepare you when the time finally arrives to sell your company. If you ticked off all the boxes above, you have a business that can enjoy premium pricing when sold.