Ways to improve your business valuation
Statistically, 61% of business owners spend either no time or less than one year planning for their exit. As a result, many of these owners settle for less than they ideally could receive in a sale and the sale process becomes more grueling itself as owners are not prepared operationally or financially for the intense scrutiny that they will receive from buyers and lenders. If you have 2-3 years to improve your business valuation, it can be time well spent. Calder recently interviewed its Analyst and Advisory team and came away with the following tips for improving your business value and making the transition smoother.
Model out how much money you need from the sale of the business to retire and achieve your goals comfortably.
- You can always make more money; it can be very difficult to stop working if you do not know how much is enough. Maybe you have enough and do not need to improve your business valuation!
- Conversely, if you stop working too early and without proper planning, you may wind up in a position of not having enough money.
- Consult with a qualified financial advisor if you do not have one. Contact Calder if you are searching for qualified contacts.
Ask yourself what the ideal transition period would look like in your mind and the role you would play in that transition period.
- If you were purchasing your business, what transition period would make you feel comfortable as a buyer?
- Oftentimes owners work until they are burned out or close to burnout, not realizing that their transition post-sale may require another 1-2 years of working, particularly in an economy where it is very difficult to find and retain upper-level management.
- If you go to market communicating that you are “done” working or will not participate substantively in a transition period, you will absolutely reduce the marketability of your business (and thus likely the value). Fewer buyers means fewer offers and less negotiating leverage.
As you get closer to a sale, show strong profits on your tax return. You will pay more in taxes, but showing strong profits not only increases buyer confidence in the earning power of your business (which should increase the price) but it is also practically necessary for lenders to see profits on a tax return to get comfortable financing a transaction.
Make the business less reliant on you, if possible.
- For example, work fewer hours by transferring your responsibilities to a newly hired manager or current manager.
- This is directly related to the last point. Your ability to transition quickly out of your business is directly tied to your level of involvement in the day-to-day operations and oversight of the business
- Additionally, businesses that are less reliant on their owners are generally more marketable.
Identify the key employees outside of you and make sure they are properly vested in the business.
- Is any manager a linchpin of the company? Consider ways, for example, bonuses, phantom stock, compensation based on recurring customer revenue - to motivate that key person to remain with the business.
- Given the endemic labor shortage, buyers are increasingly very concerned about staff morale, employee tenure, and employee loyalty. The more you can demonstrate that your team is stable, the more marketable your business will be.
- If you are considering an Employee Stock Ownership Plan (ESOP), make sure that you talk to an expert to understand what that entails. There are quite a few disadvantages to ESOPs, especially for smaller businesses, chiefly the costs to set up and maintain an ESOP and the likelihood that the value you receive will be 30-40% lower than the value the company might fetch on the market.
What is your employee base’s skillset and age mix? Do you have an aging employee base or a younger employee base?
- Hiring a diversified mix of employees is vital to the longevity of your business.
- Now, there may not be much you can do about this, but some buyers may frown on a business where the employees are largely close to retirement.
Consider how diversified your customer base is.
- While it may not be possible to shift this much prior to a sale, it’s important to understand how customer concentration may affect the deal structure.
- If one customer accounts for 30%+ of your sales and that has been consistent over time, it is reasonable to assume that a buyer will include an earn-out as part of the deal structure related to that customer.
- The earn-out is contingent payment over time based on that customer’s sales with your business. The earn-out serves as a hedge against the larger customer leaving and significantly impacting the business.
Given the endemic labor shortage, buyers are increasingly very concerned about staff morale, employee tenure, and employee loyalty. The more you can demonstrate that your team is stable, the more marketable your business will be.
Create a written business continuity plan.
- This protects the current value of the business if something were to happen to you or the key employees.
Clean up the company’s financials - eliminate as many extraordinary expenses as possible.
- As you get closer to a sale, show strong profits on your tax return.
- Yes, you will pay more taxes but showing strong profits not only increases buyer confidence in the earning power of your business (which should increase the price) but it is also practically necessary for lenders to see profits on a tax return to get comfortable financing a transaction
- Keep track of all personal discretionary expenses being expensed through the company’s P&L. If they can be substantiated, this is a great way to improve your business valuation.
Establish the value of the company’s equipment and real estate through a certified machinery and equipment appraiser and real estate appraiser.
- This should be done immediately before a sale, especially for manufacturing or other equipment-intensive businesses.
- While the “asset value” may not be the proper way to value your business, showing buyers and lenders the present value of your equipment and real estate makes the business generally more marketable and shows the buyers that you have made an effort to provide them with useful information.
Physically clean up the company’s equipment and facility to make it as presentable as possible to buyers.
- Keep up on regular maintenance and capital improvements, so your equipment is always operating well.
- If you have unused equipment, consider selling it off prior to the sale. Buyers assume that any equipment on the balance sheet/depreciation schedule will be theirs in an acquisition and selling off unused equipment prior to marketing the business gives you the opportunity to take more from the sale.
Examine and potentially reduce your inventory.
- If inventory is a big part of your business or working capital, make sure that your financials reflect an accurate level of inventory. It is common that inventory numbers on the balance sheet are not reflective of the actual inventory in the business. This can cause headaches for buyers and sellers during negotiations and prior to closing if the inventory count is not accurate.
- Many buyers will set a working capital peg or an average level of working capital that they expect to remain in the business at closing. Inventory is one component of this calculation. If an owner keeps more inventory in the business than is required, it is a good idea to sell off or reduce inventory levels before and during the sale process. This demonstrates that the actual working capital needed for the business to operate effectively is lower than the dated financials will show. This will directly impact the seller’s ability to argue that the working capital peg should be lower.
According to the IBBA Market Pulse Report, the percentage of owners who engaged in no formal planning prior to engagement to sell by deal size is as follows:
Outside of Calder Capital, make sure you establish your team of advisors, including a CPA, Financial Advisor, Attorney, Lender, etc.
- Your team is critical to a smooth acquisition and transition process.
- Conduct a legal and organization audit with your legal counsel to ensure all potential risks to the buyer have been identified and addressed.
- Make sure all leases, licenses, and other third-party agreements are in place and enforceable.
- Review the company’s internal systems, processes, and procedures to make sure a buyer can get up to speed quickly.
Consider how you would grow the company if you were 20 years younger.
- Explain precisely what could be done and what type of investment that would take. Document this, even if it’s just bullet points.
Thank you for taking the time to read these various ways to improve your business valuation. If you would like to speak confidentially to a representative from Calder Capital about please fill out the form below! Additionally, if you are interested in understanding the present value of your business, please visit here and fill out the form!