Written By: Terry Shepherd
As business owner begin to think about this next chapter of their lives, (a life no longer tied to the constant day-to-day demands and pressures of running a business), they look to their business and wonder about its cash out value and whether it will be enough. Key in this planning process is to determine the current value of the business, calculating the value gap between this value and the value they’ll need upon sale to support their desired retirement lifestyle, and the specific improvements that would be needed to maximize the value that would meet their needs.
To ensure they get this right, valuation rules of thumb should be ignored, and a formal business evaluation should be conducted. This is the starting point to determine exactly where they’re beginning from, and to help identify the company’s shortfalls that need to be corrected to build its future value. In mapping a plan, each area of improvement has an order of importance, based on the value it brings to the business that should be considered.
Below are some of the key attributes buyers should look for:
- Can this business operate independently of the owner?
- Does the business have a unique differentiator that sets it apart from all others in the industry?
- Is the business generating consistent sustainable profits?
- Is the customer base diversified and capable of further business development?
- Are the systems and processes considered first-rate for the industry?
- Is the right team in place for growing the business?
- What is the strength of the management team?
- Are there proprietary assets that have future value?
- Does the business have contracts with key stakeholders: customers, suppliers, employees, other owners?
- Is there a business plan in effect that demonstrates the business’ potential?
By matching up how the business stacks up against the questions on this list, business owners are able to readily identify areas that they can immediately begin to work on. The key concept in working on this list, is their understanding of the specific business’ value drivers. The first driver is the history of the normalized earnings and cash flow the business has generated. Is it stable with consistent growth? For the most part, cash flow is what buyers are buying, unless an owner is fortunate enough to have some unique product or other offering. Often, a strategic buyer might only be interested in the business sales volume or the specific sales territory footprint.
The second driver is the earnings multiple. This is determined by the buyer’s assessment of risk. Hence, the key here is for the business owner to work on those things that reduce Buyer risk. The lower the assessed risk, the higher the multiplier will be, which results in a higher business value. As a business owner, how do you reduce this risk? Make sure your business has few, if any, dependencies; dependencies on a single customer, supplier, employee or on you – the owner. Buyer’s risk can also be lowered by referring to the questions above and having as many ‘built-ins’ as you can; a strong management team to take over, a motivated and fully engaged team, strong culture, lean and efficient processes and systems, etc.
Monetizing the business’s value to meet desired retirement lifestyle needs, after many years of hard work, is every business owners hope and desire. To successfully plot the path to build the required value, it all begins with obtaining a formal business valuation. With so much on the line, business owners cannot afford to not get this first step right.