What is your business worth? How much could you sell it for?
Always build to sell, even if you never plan to
You may never want to sell your business. That’s fine. I understand entirely. You built it from scratch. You're proud of it. It gives you income and something meaningful to put your energy into. However, you should always build your business as if you were going to sell it. Even if you never plan to. The reason for this is simple.
A sellable business is a healthy business.
It is well-run and profitable
Enjoys an excellent reputation backed by great ratings and reviews
Understands and tracks key numbers and metrics with a simple dashboard
Has a positive culture with a team of secure, happy staff
Is efficient with clear systems and processes
Has a strong, happy customer base
Most importantly, a sellable business does not rely on the owner to always be around. A business generally has a higher valuation when the owner's involvement in daily operations is minimal.
This sounds like a great business to own and keep! So, whether you’re planning to sell, or not, always build to sell. As my dad often said, sell the fruit, not the tree.
How much could you sell your business for?
The simple, straightforward answer is that you can only sell your business for the amount someone is willing to pay. Their willingness will be based on the value you can show.
Remember, people who buy businesses are intelligent and savvy. And it’s usually not their first time. They know what to look for, what questions to ask. They know how much they want to pay, based on their ideal return on investment.
Your job is to tell them a compelling story of why your business is worth what you want to sell it for. They are buying the future potential based on what they see has happened in the past. Here is where you need to start.
Business Valuation Methods
Here are three common business valuation methods to clarify what your business could be worth, and how to maximise your business's sale price. The following examples are based on a business with an annual profit of $100,000 and $15,000 in materials and equipment.
1. Income Method
The income method focuses on the business's future earnings potential. A common approach is to multiply the business's profit by a specific factor, known as a multiple. This multiple reflects the risk, growth prospects, and market conditions.
Profit Multiple: This method involves multiplying the business's maintainable earnings (often the net profit) by a suitable multiple. Remember, actual profit is calculated by deducting all expenses from the total revenue. If you have not paid yourself an industry-standard wage for what you do in the business, a potential buyer will see that and subtract it from the profit.
The multiple varies depending on the industry, the business's size, growth potential, and the prevailing economic conditions. A typical range is between 2 and 3, but can be higher or lower.
Calculation Example
Annual Profit: $100,000
Multiple: 2 to 3
Valuation Range: $100,000 x 2 = $200,000 to $100,000 x 3 = $300,000
Possible Selling Price
Based on this method, a potential selling price range is $200,000 to $300,000.
How to Increase Value with the Income Method
A business owner can increase the value of their business under the income method by focusing on strategies that increase profit and demonstrate the sustainability of that profit. This can be achieved through various avenues, including:
Running targeted marketing and sales campaigns to attract new customers and increase sales.
Forming strategic partnerships with complementary businesses to expand market reach.
Improving operational efficiency and streamlining systems to reduce waste and lower operating costs.
Carefully raising prices to increase revenue while remaining competitive.
Negotiating better pricing with suppliers or exploring more cost-effective sourcing.
Diversifying revenue streams.
Demonstrating a history of consistent and growing profits.
Grow your company database and brand audience, and build strong relationships that can lead to future sales.
2. Asset Method (Asset Valuation Method)
The asset method values a business based on the value of its net assets (total assets minus total liabilities). This method is often used for businesses with significant tangible assets, such as manufacturing or retail businesses. There are a few ways to calculate asset value:
Book Value: The value of assets as recorded on the company's balance sheet. This method is rarely used for business sales, as book value often differs significantly from market value.
Adjusted Net Asset Value: This adjusts the book value of assets to their fair market value.
Liquidation Value: The net amount that could be raised if the business was terminated and assets sold.
Calculation Example (Adjusted Net Asset Value):
Materials and Equipment: $15,000 (Assuming this represents the fair market value of tangible assets, and for simplicity, we'll assume no liabilities for this example)
Adjusted Net Asset Value: $15,000
Possible Selling Price
Based on the information given, a fundamental asset valuation is $15,000. However, this is likely a *very* low valuation, as it doesn't account for intangible assets or the business's earning power. In a real-world scenario, a full asset valuation would be more complex.
How to Increase Value with the Asset Method
To improve a business's value using the asset method, the owner should focus on maximising the value of its assets and minimising its liabilities. Here are some strategies:
Regularly maintain and upgrade tangible assets: Ensure equipment, property, and inventory are in excellent condition.
Dispose of obsolete or underperforming assets: Eliminate assets that no longer contribute to profitability.
Accurate inventory management: Implement systems to track and manage inventory efficiently, reducing waste and maximising its value.
Negotiate favourable lease terms: If the business leases property or equipment, negotiate favourable terms to minimise liabilities.
Collect receivables: Implement efficient systems for collecting accounts receivable to improve cash flow and reduce the risk of bad debts.
Manage liabilities: Reduce liabilities where possible and ensure that the terms of any loans or other debts are favourable.
Document asset value: Maintain accurate and up-to-date records of the fair market value of all assets.
Protect intellectual property: Ensure that all intellectual property is legally protected.
3. Market-Based Method (Comparable Sales Method)
The market-based method determines the value of a business by comparing it to similar businesses that have recently been sold. This method relies on finding comparable transactions in the same industry and geographic area.
Comparable Sales Analysis: This involves identifying similar businesses sold and analysing the sale prices and key metrics (e.g., revenue, profit) of those transactions. The valuation is then derived by applying relevant multiples or ratios from the comparable sales to the subject business.
Example
Find three similar businesses in Sydney that recently sold.
Business A sold for $250,000 with a profit of $80,000 (Multiple of 3.125).
Business B sold for $300,000 with a profit of $100,000 (Multiple of 3).
Business C sold for $200,000 with a profit of $60,000 (Multiple of 3.33).
Average Multiple: (3.125 + 3 + 3.33) / 3 = 3.15
Valuation: $100,000 (Subject Business Profit) x 3.15 = $315,000
Possible Selling Price
Based on this example, a potential selling price is $315,000. This method relies heavily on finding comparable sales data, which can sometimes be challenging.
How to Increase Value with the Market-Based Method
To increase a business's value under the market-based method, the owner should focus on making their business more attractive to potential buyers compared to its competitors. Here's how:
Improve financial performance: Strive to exceed the financial performance of comparable businesses in terms of revenue growth, profitability, and cash flow.
Differentiate the business: Develop a unique selling proposition (USP) that sets the business apart from its competitors. This could be a superior product or service, a strong brand, a loyal customer base, or a unique business model.
Strengthen competitive advantages: Enhance any existing competitive advantages, such as proprietary technology, exclusive contracts, or a dominant market share.
Enhance business operations: Optimise operational efficiency, streamline processes, and implement best practices to make the business more efficient and profitable than its competitors.
Build a strong brand: Invest in branding and marketing to create a strong and recognisable brand that resonates with customers.
Develop a loyal customer base: Focus on building strong relationships with customers and creating a loyal customer base.
Document business processes: Document all key business processes and systems to make the business more transparent and easier for a buyer to transition.
Show growth potential: Demonstrate the business's potential for future growth and expansion.
Maximising the Sale Price - 6 to 12 Month Plan to Prepare for Sale
The owner should undertake a strategic approach over the next 6 to 12 months to achieve the best possible price for their business. Here's a plan:
Financial Review and Improvement
Clean and Accurate Records: Ensure all financial records (profit and loss statements, balance sheets, tax returns) are accurate, up-to-date, and well-organised. Consider an audit or review by an independent accountant.
Identify and Address Weaknesses: Analyse financial statements to identify areas for improvement. This might include reducing expenses, increasing revenue, or improving cash flow.
Normalise Earnings: Adjust financial statements to reflect the true earnings potential of the business. This may involve removing non-recurring items (e.g., one-time gains or losses) or adjusting for the owner's salary if it's significantly above or below market value.
Document Everything: Keep detailed documentation of all financial information, contracts, leases, and other relevant documents.
Operational Enhancements
Streamline Processes: Identify and improve operational inefficiencies. This could involve optimising workflows, implementing new technology, or improving inventory management.
Strengthen Management Team: If the business relies heavily on the owner, develop a strong management team that can operate the business independently. This makes the business more attractive to buyers.
Customer and Supplier Relationships: Solidify relationships with key customers and suppliers. Long-term contracts or agreements can add value.
Document Key Information: Document all operational processes, customer information, supplier agreements, and other critical business information.
Legal and Compliance Review
Legal Health Check: Ensure the business fully complies with all relevant laws and regulations.
Contracts and Agreements: Review all contracts, leases, and agreements to ensure they are in order and transferable.
Intellectual Property: Protect any intellectual property (e.g., trademarks, patents, copyrights).
Resolve Disputes: Address any outstanding legal disputes or potential liabilities.
Sales Preparation
Professional Valuation: Obtain a professional business valuation from a qualified appraiser. This will objectively assess the business's value and help set a realistic asking price.
Prepare a Detailed Information Memorandum (IM): Create a comprehensive document that provides potential buyers with detailed information about the business, including its history, financials, operations, and future prospects.
Identify Potential Buyers: Identify potential buyers through business brokers, industry contacts, and online platforms.
Marketing Strategy: Develop a marketing strategy to reach potential buyers and promote the business for sale.
Due Diligence Preparation: Anticipate the due diligence process and prepare all necessary documentation.
What Potential Buyers Want to See and Understand
Potential buyers typically want to see and understand the following:
Financial Performance:
Consistent and growing revenue and profitability.
Precise and accurate financial statements.
Sustainable earnings.
Strong cash flow.
Business Operations:
Efficient and well-documented processes.
A strong management team.
A diversified customer base.
Reliable supplier relationships.
Growth Potential:
Opportunities for future growth and expansion.
A clear competitive advantage.
A strong market position.
Risks and Opportunities:
A clear understanding of the risks and opportunities associated with the business.
A plan to mitigate risks and capitalise on opportunities.
Due Diligence:
Buyers will conduct thorough due diligence. They want full cooperation and transparency.
Be prepared to provide detailed information and answer questions promptly.
Intangible Assets:
The value of intangible assets like brand reputation, customer relationships, and intellectual property.
By addressing these factors and preparing the business for sale, the owner can significantly increase its attractiveness to potential buyers and maximise the sale price.
If you’d like to go deeper
Book a complimentary strategy session with us here to work through what you’d like to achieve in your business
