Most small business owners never think for a second about what their small business is actually worth until it’s time to think about what it’s actually worth. This article will explain the biggest factors that contribute the most to your company valuations.
By the time most business owners get around to thinking what their small business worth, it’s usually when they want to sell and it’s too late to actually change things and fix what needs fixing. In many cases either investors are put off or the owner sells for way less than they wanted to. Or even worse, they’re stuck with a business they hate.
You Don’t Want to Be Dependent on Anyone[wpsm_column size=”one-half”] [wpsm_titlebox title=”Table of Contents” style=”1″][contents h2 h3][/wpsm_titlebox] [/wpsm_column]
While most business consultants will focus on the need to diversify the customer base, there are three main factors to this.
First is you have to be independent of customers. You need a good diversification of your customers. If 70% of your small business is coming from one customer, then as an investor I’ll look at your business in a cheaper way right from the get go.
Second is about employees: you can’t rely on any one employee to manage a large part of your small business. Investors want to know that if anything happens to that employee, they can easily replace them.
Thirdly, you can’t be dependent on one supplier. That’s a big no for any potential investor, and scares investors away.
The key idea is diversification – Customers, Employees and Suppliers. As the business owner, you need to ensure you have diversification on all three of those.
When a potential investor is about to buy your small business and he see you are dependent on any one of those three, your business will be pretty much worthless – your business will be worth much if you had those three aspects diversified.
The most valuable companies are structured this way, they aren’t dependent on one individual. Diversification is actually part of their “DNA”.
In order to secure your financial freedom you should ask yourself what can you do today to reduce your reliance on one thing in each of those three areas and increase the value of your business.
Focus on Your Small Business Financial Performance: Your Top Line Revenue, and Your Bottom Line Profit
In the paragraph above we said that most business owners don’t think for a second on what their small businesses are actually worth, and when they do think about it it’s usually too late to fix or change things, and they end up stuck with a business that’s draining them mentally and physically.
It doesn’t have to be that way and this is the reason you are reading this article.
Top line revenue and bottom line profit aren’t the only numbers that are relevant when valuing your small business. But those are really important to begin with, and the QUALITY of the reports of those numbers really matter, almost just as much.
In order to drive up your valuation, don’t just focus on good financial performance, but also consider investing in an audit to show that your numbers are legit. We recommend that you get a 3rd party to check your financials. That will add a lot of value.
Again, three things, like in the paragraph above: your overall revenue, profit margin, and the
quality of your bookkeeping. Make sure that you get these three right.
We would like to emphasize one thing about your revenue – the bigger your business is, the more you’ll get offered…Because size matters! The smaller you are, you’ll get lower multiples, because it looks like the business is even more dependent on the owner.
The things you want to focus on to increase valuation is first to increase revenue as much as possible, then increase your profit margin and make sure that you have legit, clean, ideally audited financials from a third party company.
Make sure that you focus on daily basis to increase both revenue and profit. It’s not enough to focus on just one of those. If all you focus on is to increase revenue at the expense of your profit margin then a potential buyer will look at that and see your gross margin is dropping as your revenue is increasing. That makes it look like your best days are behind you, and you were able to grow only by dropping your price.
Ask yourself – What are you going to do today to focus on those three areas to improve your valuation – your overall revenue, profit margin, and quality of your bookkeeping.
Improve the Way Cash Moves Through Your Business
Worrying if you’ll get a payment from a customer tomorrow to have the cash to pay an invoice that’s just come in is no fun. When the arteries of your small business are blocked like that, everyone and everything gets paid late – Suppliers, employees, product development costs and more.
And if you want to sell your small business…That’s a huge red flag to a potential buyer. You want to remember when someone is buying a company they’re making two deposits: One is to YOU to buy the business. The second is to finance your working capital. That’s the money your business needs to operate day to day operations.
The more cash your company needs to operate, the less a potential buyer will be excited to buy your small business because that’s more money out of his business.
So how can you improve the way cash moves through your company?
The first, and pretty obvious answer, is to make sure your business is generating cash.
So how do you do that?
First – Get paid faster. if you’re in a business where you send invoices, is it possible to send those invoices and collect money more quickly? Can you reduce a 30 day payment to 15 days? Or charge a bigger deposit, increase it from 5% to 30%? That will help your cash situation a LOT because the money your small business generates will be in your hand faster and for longer. Another way you can get paid faster is by factoring your invoices.
Second – Pay your bills slower. You need to manage your payables better. Let’s assume that suppliers ask you to pay in 30 days, can you stretch it to 45 days? Are you using
credit cards effectively? 10-15 days of float…are you using that?
Money coming in faster, money going out slower – Equals more cash IN your small business at any given moment. You might think 5 days here or 10 days there doesn’t matter much, but it creates an overall difference when you pay your bills slower and get paid faster.
Improved cash flow will drive the value of your company a lot. because a buyer looking at the cashflow of your small business will know they won’t have to immediately inject a ton of cash to get it working properly.[also-recommended-box title=”” href_title=”Cash flow Strategies for Your Struggling Small Business” rel=”/blog/cash-flow-strategies-for-your-struggling-small-business//” type=”3″] Recommended Reading for You: [/also-recommended-box]
Ask yourself what can you do today to get paid faster and pay your bills slower? You can also sit down with your employees and ask them about it.
Use Small Business Loans to Boost Your Performance
Small business loans are usually used to cover urgent expenses such as salaries or unexpected expenses, such as paying for office or vehicle repairs and adding inventory during a seasonal spike in demand.
However, you can also use small business loans improve your overall business performance. One example is to buy more from suppliers and vendors and translate it into increased leverage to negotiate better terms, such as bigger discounts and more time to pay your invoices.
You can also use small business loans to hire new talents and compete with the your top peers when it comes to onboarding and retaining top talent employees.
Another way that small business loan can be utilized to increase the performance of your small business is by extending existing lines of products. This is an effective way for businesses to diversify revenue streams and enter into new markets. Taking out a small business loan provides the leverage your business needs to modify and evolve its suite of offerings, which is essential for growth and stability, and put your small business in position to succeed over the long-term.
Reflect the Growth potential of your Small Business
We’ve been covering how to increase the value of your small business for sale, because business owners don’t think about this until they have to…and then it’s too late and they sell for cheap.
In the first paragraph we’ve covered diversification in three key areas.
In the second we’ve covered 3 fundamentals of your financials to get straight.
We’ll be continuing to cover the few factors that contribute the most to the valuation of your small business when you’re looking to sell.
Many small business owners want to value their business based on what they’ve done in the past. That’s a normal valuation strategy, and it works great.
But if you want to get the most out of your business selling price, try to position it to your buyer based on the FUTURE growth potential of your business. It’s the FUTURE of your business that investors buy. They only care about the future.
Ignore this and all you have is a past that no one cares about.
So do some reverse engineering. Think about where they’re coming from. For you, the seller, selling your small business is the finish line. But for the investor, it’s the start line.
it is crucial that you make the case for your small business potential and present things like – How it will operate in a different market, If your business have been successful in a market A, can it be scaled to market C or D?. Make sure that you present cross selling opportunities and any way you can scale the business up. If you can demonstrate the potential in these things, you can ask for a much higher selling price.
How strong you can make this case? that’s what’s going to drive up the value of your business. If you can show you can scale much more quickly, you can get much larger multiples.
For example, let’s say you woke up tomorrow, and you had ten times more customers to serve. How easy would it be for you to handle that demand? If your answer is impossible, its really hard to get larger multiples as opposed to companies that can answer that easily.
The more you can demonstrate future growth, the more valuable it’s going to be. Investors saw Uber had crazy potential. As a result of their quick growth, they got a valuation of 50 billion dollars. All based on their growth potential. Investors buy that growth story.
If you want to get higher multiples for your business, you should ask yourself how can you craft a compelling growth story? And how are you going to demonstrate to potential buyers that you have no growth limits?
Make Sure Your Small Business Is Stable and Enjoy a Recurring Revenue Stream
We’ve been through a few reasons on what affects your business value when you’re about to sell it.
- Growth potential
- Get paid faster, pay slower
The focus in this paragraph is the BIG question on a buyers mind: how will the business keep working when the owner is out?
If a large part of the business depends on you, that’s a no-go zone for a potential buyer. One of the elegant ways to reassure a buyer is through recurring revenue. The more recurring revenue you can have, the more valuable your small business will be (because it’s less dependent on you).
A few examples of recurring revenue are: long term contracts with clients or renewal plans and subscribers.
You want to think about how you can convert one-time purchases to subscription models.
The more clients you have like this, the more valuable your business will be. You always want to think about how can you add a product that’s more than a one time transaction and can repeat itself.
The more recurring revenue your business generate, the higher the valuation will be.
Let’s say you have a company that’s generated good money but as a one time thing. If your competitor makes this same amount of money with recurring revenue, then that business will be worth 2-3 times more than yours.
Recurring revenue might skyrocket your business value like nothing else. You might think that your customers won’t be interested in subscriptions in your industry. You need to give it a thought and look at ways to incorporate this into your business. Maybe it’s by offering subscriptions on existing products and incentivizing your existing customers to sign up by giving them a recurring discount. Or maybe it’s thinking of products related to your existing products that your customers will need over and over again.
By setting up these payments that will continue to come in whether you’re still part of the business or not, your small business will immediately become more attractive to potential buyers, and you’ll have leverage to ask for a higher price!
So ask yourself, what can I do to change my one time product into recurring purchases?
As a small business owner you must discover the value gaps in your business. If you want to list your business for sale, you should ramp up your marketing and sales and make sure you have a solid plan for growth. Buyers pay more for growing businesses than ones that are stagnant.