The Variables that Drive and Influence Business Valuations
If you’ve never bought or sold a business before, then the factors that drive and influence business valuations likely seem a bit murky. In a recent Divestopedia article from Kevin Ramsier entitled, “A Closer Look at What Drives and Influences Business Valuations,” Ramsier takes a closer look at this important topic.
Business brokers and M&A advisors play a key role in helping business owners understand why their business receives the valuation that it does. No doubt, the final assessed value is based on a wide array of variables. But with some effort, clarity is possible.
In his article, Ramsier points out that “value means different things to different buyers” and that the “perceived value depends on the circumstances, interpretation and the role that is played in a transition.” It is important to remember that no two businesses are alike. For that reason, what goes into a given valuation will vary, often greatly.
Looking to EBITDA
Ramier points to several metrics including return on assets, return on equity and return on investment. Another important valuable for companies with positive cash flow is a multiple of EBITDA, which stands for “earnings before interest, taxes, depreciation and amortization.” EBITDA is widely used in determining value. On the flip side of the coin, if the company in question has a negative cash flow, then the liquidation value of the business will play a large role in determining its value.
Primary Drivers to Consider
Ramsier provides a guideline of Primary Drivers of Valuation, Secondary Drivers of Valuation and Other Potential Drivers of Valuation. In total there are 25 different variables listed, which underscores the overall potential complexity of accurately determining valuation.
In the Primary Drivers of Valuation list, Ramsier includes everything from the size of revenue and revenue stability to historical and projected EBITDA as well as potential growth and margin percentages. Other variables, ones that could easily be overlooked, such as the local talent pool and people training are also listed as variables that should be considered.
Support for the Business Owner
The bottom line is that determining valuation is not a one-dimensional affair, but is instead a dynamic and complex process. One of the single best moves any business owner can make is to reach out to an experienced business broker. Since business brokers are experts in determining valuation, owners working with brokers will know what to expect when the time comes to sell.
Is Your Business Really Worth Handing Over to the Next Generation?
Before you begin your business, you should be thinking about how you will hand that business over to someone else. No one runs a business forever. Whether you sell your business or let a relative inherit it, at some point you will need to step away.
When you finally do separate from your business, it is critical that you are certain that it is worth handing over. In his January 2019 article in Forbes magazine entitled “Make Sure Your Business is Worth Handing Over,” author Francois Botha dives in and explores this very topic.
In this article, Botha emphasizes that family businesses should not “fall into the trap of prioritizing job creation for their children.” Instead, that the priority should be to perpetuate the business. Botha cites the co-founder and chairman of The Leadership Pipeline Institute, Stephen Drotter, who feels that the main goal of any business needs to be its suitability.
Drotter established five principles designed to assist family businesses as they seek to prepare for succession. The first principle is to “Identify and Fix Your Problems.” Current ownership should deal promptly with any business problems before passing a business on to a new generation.
The second principle Drotter covers is to “Adjust Your Management to the Strategic Evolution of Your Business.” Businesses evolve from the creation of a product to sell to focusing on sales, marketing and distribution to finally addressing a plateau in sales which facilitates the need for multi-functional management.
The third principle cited by Drotter is “Talk to Your People About Them.” In this principle, communication with employees is key. Getting to know and understand employees is vital.
“Be on the Lookout for Talent Everywhere,” is the fourth principle. There is no replacement for skilled and motivated employees, and you never know where you may find them.
Finally, the fifth principle, “Provide Development” emphasizes that “almost everything is learned, and somebody often taught that which is learned.” Employee skill must be seen as a key priority.
Making sure that a business is ready for transition to the next generation involves careful preparation and a good deal of advanced planning. The sooner that you begin asking the right kind of thoughtful questions about the current state of your business and what will benefit it moving forward, the better off everyone will be.
Erase the Stress of Selling Your Business by Finding the Right Buyer
There is no denying the fact that life is much, much easier when one can find the right buyer for his or her business. Buying or selling a business can be a stressful affair, but much of that stress can be eliminated by getting the right support.
The Concept of the “Right Buyer”
In the recent Inc. article entitled, “How to Find the Right Buyer for Your Business and Avoid Negative Consequences,” Bob House builds his article around a relatively simple and straightforward, but powerful, concept. House’s notion is, “the right buyer is worth more than a big check.”
House correctly points out that far too many sellers become fixated on exiting their business and grabbing a big pay day. In their focused interest in the sum they will receive, these sellers ignore a range of other important details. In part, sellers often miss the single greatest variable in the entire process: finding the most qualified buyer. The simple fact is that if sellers want to reduce their long-term stress, then there is no replacement for finding the most qualified buyer, as the wrong buyer can be “headache city!”
Plan in Advance
As House points out, it is only prudent to determine what you want out of a buyer well before you put your business up for sale. For example, if you don’t want to offer financing, then that is a decision you need to make well before you begin the process.
Additionally, House wisely places considerable interest on pre-screening potential buyers. Pre-screening is a great reason to work with an experienced and proven business broker who can assist with the process. As a business owner your time is precious. The last thing you want are a lot of window shoppers wasting your time.
Keep Your Focus on Your Business
Remember, while your business is up for sale, you still have to run your business. Quite often, business owners have difficulty running their business and navigating the complex sales process simultaneously. The end result can be disastrous, as revenue can drop and business problems can arise.
Working with a business broker means that you are dramatically reducing your potential stressors throughout the sales process. A business broker will ensure that potential buyers are pre-screened and that only serious buyers are brought to you for consideration.
Currently, the market conditions are great for sellers. If you are considering selling, now is the time to find a business broker and jump into the market!
Do You Know What Kind of Business Owner You Really Are?
Does your business have real, long-lasting longevity or is your business a temporary entity that will vanish the second you stop working on it? In his insightful article in The Business Journals entitled, “Are You Living for Today as a Business Owner or Building Value?” author Kent Bernhard asks a very important question of readers, “Are you a lifestyle business owner or a value accelerator?”
Many business owners have never stopped to ask this very important, yet basic, question regarding their businesses. So, let’s turn our attention to this key question that all business owners must stop and ask at some point.
As Bernhard points out the core issue here is how a given business owner defines the idea of success for him or herself. As Chuck Richards, the CEO of CoreValue Software notes, “At the end of the day, a lifestyle business is just a job.”
Richards goes on to note that this is fine for many people. But if this is the case, it is a choice that one is making. Therefore, lifestyle business owners should be aware that they are, in fact, clearly making a choice.
Business owners who are lawyers, consultants and accountants often fall into the category of those with a “business as a job.” They fail to accumulate enough assets for their business to really be more than a job. Summed up in another fashion, the business generates enough revenue to provide a comfortable lifestyle. However, it does not have the infrastructure or equity to remain profitable, or even in existence, once they walk away. As the owner and operator of the business, they are vital to its very existence. This means that the business only has value so long as the owner is working in the business on a regular basis. As a result, the owner may never really be able to exit the business.
As Bernhard points out, “To build a business as an asset, you have to become a value accelerator who looks beyond whether the business’ profits are sufficient to maintain your lifestyle. It means looking at the business as an entity outside yourself.” Those who fall into the value accelerator category, focus on figuring out creating value for the business as a financial asset that can operate independently.
Making sure that your business can continue on without you means that you have to build it, and that involves having a coherent and focused plan. Plan in advance and know how you will exit your business. To ultimately create value for the business entity itself, a plan must be in place that allows for your successful exit.
How Employees Factor into the Success of Your Business
Quality employees are essential for the long-term success and growth of any business. Many entrepreneurs learn this simple fact far too late. Regardless of what kind of business you own, a handful of key employees can either make or break you. Sadly, businesses have been destroyed by employees that don’t care, or even worse, are actually working to undermine the business that employs them. In short, the more you evaluate your employees, the better off you and your business will be.
Forbes’ article “Identifying Key Employees When Buying a Business”, from Richard Parker does a fine job in encouraging entrepreneurs to think more about how their employees impact their businesses and the importance of factoring in employees when considering the purchase of a business.
As Parker states, “One of the most important components when evaluating a business for sale is investigating its employees.” This statement does not only apply to buyers. Of course, with this fact in mind, sellers should take every step possible to build a great team long before a business is placed on the market.
There are many variables to consider when evaluating employees. It is critical, as Parker points out, to determine exactly how much of the work burden the owner of the business is shouldering. If an owner is trying to “do it all, all the time” then buyers must determine who can help shoulder some of the responsibility, as this is key for growth.
In Parker’s view, one of the first steps in the buyer’s due diligence process is to identify key employees. Parker strongly encourages buyers to determine how the business will fair if these employees were to leave or cross over to a competitor. Assessing if an employee is valuable involves more than simply evaluating an employee’s current benefit. Their future value and potential damage they could cause upon leaving are all factors that must be weighed. Wisely, Parker recommends having a test period where you can evaluate employees and the business before entering into a formal agreement.
It is key to never forget that your employees help you build your business. The importance of specific employees to any given business varies widely. But sellers should understand what employees are key and why. Additionally, sellers should be able to articulate how key employees can be replaced and even have a plan for doing so. Since, savvy buyers will understand the importance of key employees and evaluate them, it is essential that sellers are prepared to have their employees placed under the microscope along with the rest of their business.
