Key factors influencing small business valuation
As a business owner, you obviously want to be cognizant of decisions and factors within your business that will positively or negatively influence its value. Below is a breakdown of some key areas you can focus on today to ensure that your company’s value is protected should you ever need to conduct a business valuation and if you ever plan to sell:
- Maintain clean financial books and records
- Keeping business and personal expenses separate is ideal. For many small business owners, they treat the company’s cash flow like a personal checking account. Often times family expenses beyond owner compensation are being paid by the business such as meals, vacations, automobile, gas, insurance, phones, etc. When preparing a business to sell, not only would these “owner benefits” be reflected back into the company’s earnings, but it will also have to be explained to a potentially skeptical buyer. Keeping these types of expenses separate is of value when owners want to avoid buyer skepticism.
- Studies from major accounting firms and even our own experiences have indicated that companies with audited financials, or at least professionally managed books for small businesses, will consistently fetch a higher purchase price than those not well kept. If it’s not documented, it’s not accounted for.
- Achieve for positive trending
- Typically, the most recent 3-5 years of performance and 2-3 projections will be the closest examined periods in determining a company’s value. Showing positive trends and growth in both revenues, net income and “owner’s discretionary earnings” will have a significant impact on value. When businesses suffer due to factors out of their control (industry dips, seasonal declines, etc) those can more easily be accounted for. When the business declines due to lack of performance on its own accord in comparison to similar companies in a similar industry, this will certainly drop a company’s fair market value and strategic value.
- Buyer’s are purchasing future cash flows and potential. If you’re in a decline, why would a buyer pay a premium? Many business owners, rightfully so, believe their company is worth much more than it is due to the time, sweat, and effort invested into their business. Owners who can step away from the situation and evaluate their business from a buyer’s perspective will appreciate the fact that positively trending cash flow and a positive outlook into the future will make the company that much more attractive and valuable.
- Profitable process chain
- With today’s advances in technology and automation, a company’s systems and process chain requires evolution. Business owners who accept change and readily adapt to more efficient and productive ways to operate their business will not only increase profits, but also building a system that can sustain additional growth will less operational costs required. Such automation or process changes can greatly impact value as the future operational and profit prospects of the business or ideal.
- If your company is involved in the production of a product or service, you should evaluate your company’s core strengths and weaknesses. Many owner’s in today’s world are outsourcing elements of their process chain. While letting go control of certain aspects of your business can prove daunting, owners who find strategic partners to produce or manufacture key processes in their business can become much more efficient, increase quality, profitability and customer satisfaction. Identify opportunities and seek out expert partners who you can strategically outsource to.
- Make the business less reliant on you
- If you wanted to, could you take off on vacation of the next 2-3 weeks (minimum) and your company not skip a beat? If not, strive for this goal. When a company is heavily reliant on an owner who works “in” the business, it is more susceptible to a lower valuation. This is certainly true for companies with less than 10 employees where often times the owner is the business. In his or her absence, clients will leave and the company’s ability to function is all but paralyzed. Owner’s who can develop sound processes, responsible management, and a value chain to serve clients will be able to step away from working “in” the business and work “on” the business.
- When a small business owner sells, the buyer will typically step in to run the company, as opposed to hiring a manager to run it for them. It is important that a current owner lay the foundation for a completely new individual to seamlessly walk into the business and have the ability to successfully run it within 3-6 months time. Making it as easy on a buyer to take over management is key in maintain and creating value in your business.
There are certainly many other major factors that will influence the value of a business (goodwill, client acquisition efficiencies, competitive landscape, fixed assets, inventory etc), but some of the above examples you can address sooner rather than later for a positive business valuation. Know your value, Know your business. If you have any other tips or advice, please leave a comment.