Tag Archives: Sellability Score

Business Valuation

Republished with permission from Built to Sell Inc.

Deck: Business valuation goes beyond simple mathematics, but to get some idea of what your business might be worth, consider the three methods below.

Your business is likely your largest asset so it’s normal to want to know what it is worth. The problem is: business valuation is what one might call a “subjective science.”

The science part is what people go to school to learn: you can get an MBA or a degree in finance, or you can learn the theory behind business valuation and earn professional credentials as a business valuation professional.

The subjective part is that every buyer’s circumstances are different, and therefore two buyers could see the same set of company financials and offer vastly different amounts to buy the business.

This article provides the basic science and math behind the most common business valuation techniques, but keep in mind that there will always be outliers that fall well outside of these frameworks. These are strategic sales, where a business is valued based on what it is worth in the acquirer’s hands. Strategic acquisitions, however, represent the minority of acquisitions, so use the three methods below to triangulate around a realistic value for your company:

Assets-based

The most basic way to value a business is to consider the value of its hard assets minus its debts. Imagine a landscaping company with trucks and gardening equipment. These hard assets have value, which can be calculated by estimating the resale value of your equipment.

This valuation method often renders the lowest value for your company because it assumes your company does not have any “Good Will.” In accountant speak, “Good Will” has nothing to do with how much people like your company; Good Will is defined as the difference between your company’s market value (what someone is willing to pay for it) and the value of your net assets (assets minus liabilities).

Typically, companies have at least some Good Will, so in most cases you get a higher valuation by using one of the other two methods described below.

Discounted Cash Flow

In this method, the acquirer is estimating what your future stream of cash flow is worth to them today. They start by trying to figure out how much profit you expect to make in the next few years. The more stable and predictable your cash flows, the more years of future cash they will consider.

Once the buyer has an estimate of how much profit you’re likely to make in the foreseeable future, and what your business will be worth when they want to sell it in the future, the buyer will apply a “discount rate” that takes into consideration the time value of money. The discount rate is determined by the acquirer’s cost of capital and how risky they perceive your business to be.

Rather than getting hung up on the math behind the discounted cash flow valuation technique, it’s better to understand the drivers of your value when you use this method. They are: 1) how much profit your business is expected to make in the future; and 2) how reliable those estimates are.

Note that business valuation techniques are either/or and not a combination. For example, if you are using Discounted Cash Flow, the hard assets of the company are assumed to be integral to the generation of the profit the acquirer is buying and therefore not included in the calculation of your company’s value.

A money-losing bed and breakfast sitting on a $2 million piece of land is going to be better off using the Asset-based valuation method; whereas a professional services firm that expects to earn $500,000 in profit next year, but has little in the way of hard assets, will garner a higher valuation using the Discounted Cash Flow method or the Comparables technique described below.

Comparables

Another common valuation technique is to look at the value of comparable companies that have sold recently or for whom their value is public. For example, accounting firms typically trade at one times gross recurring fees. Home and office security companies trade at about two times monitoring revenue, and most security company owners know the Comparables technique because they are often getting approached to sell by private equity firms rolling up small security firms. Typically you can find out what companies in your industry are selling for by asking around at your annual industry conference.

The problem with using the Comparables methodology is that it often leads owners to make an apples-to-bananas comparison. For example, a small medical device manufacturer might think that, because GE is trading for 20 times last year’s earnings on the New York Stock Exchange, they too are worth 20 times last year’s profit. However, if one looks at the more than 13,000 businesses analyzed through the The Value Builder System, it’s clear that a small medical device manufacturer is likely to trade closer to five times pre-tax profit.

Small companies are deeply discounted when compared to their Fortune 500 counterparts, so comparing your company with a Fortune 500 giant will typically lead to disappointment.

Finally, the worst part about selling your business is that you don’t get to decide which methodology the acquirer chooses. An acquirer will do the math on what your business is worth to them behind closed doors. They may decide your business is strategic, in which case back up the Brinks truck because you’re about to get handsomely rewarded for your company. But in most cases, an acquirer will use one of the three techniques described here to come up with an offer to buy your business.

Sellability Score

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

What a Study of 14,000 Businesses Reveals About How You Should Not Be Spending Your Time

Republished with permission from Built to Sell Inc.

In an analysis of more than 14,000 businesses, a new study finds the most valuable companies take a contrarian approach to the boss doing the selling.

Who does the selling in your business? My guess is that when you’re personally involved in doing the selling, your business is a whole lot more profitable than the months when you leave the selling to others.

That makes sense because you’re likely the most passionate advocate for your business. You have the most industry knowledge and the widest network of industry connections.

If your goal is to maximize your company’s profit at all costs, you may have come to the conclusion that you should spend most of your time out of the office selling, and leave the dirty work of operating your businesses to your underlings.

However, if your goal is to build a valuable company—one you can sell down the road—you can’t be your company’s number one salesperson. In fact, the less you know your customers personally, the more valuable your business.

The Proof: A Study of 14,000 Businesses

We’ve just finished analyzed our pool of Sellability Score users for the quarter ending December 31. We offer The Sellability Score questionnaire as the first of twelve steps in The Value Builder System, a statistically proven methodology for increasing the value of a business.

We asked 14,000 business owners if they had received an offer to buy their business in the last 12 months, and if so, what multiple of their pre-tax profit the offer represented. We then compared the offer made to the following question:

Which of the following best describes your personal relationship with your company’s customers?

  • I know each of my customers by first name and they expect that I personally get involved when they buy from my company.
  • I know most of my customers by first name and they usually want to deal with me rather than one of my employees.
  • I know some of my customers by first name and a few of them prefer to deal with me rather than one of my employees.
  • I don’t know my customers personally and rarely get involved in serving an individual customer.

2.93 vs. 4.49 Times

The average offer received among all of the businesses we analyzed was 3.7 times pre-tax profit. However, when we isolated just those businesses where the owner does not know his/her customers personally and rarely gets involved in serving an individual customer, the offer multiple went up to 4.49.

Companies where the founder knows each of his/her customers by first name get discounted, earning offers of just 2.93 times pre-tax profit.

When Value Is the Enemy of Profit

Who you get to do the selling in your company is just one of many examples where the actions you take to build a valuable company are different than what you do to maximize your profit. If all you wanted was a fat bottom line, you likely wouldn’t invest in upgrading your website or spend much time thinking about the squishy business of company culture.

How much money you make each year is important, but how you earn that profit will have a greater impact on the value of your company in the long run.

Sellability Score

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

6 Reasons Not To Diversify

Republished with permission from Built to Sell Inc.

Deck: Diversification is a sound financial planning strategy, but does it work for company building?

How does Vitamix get away with charging $700 for a blender when reputable companies like Cuisinart and Breville make blenders for less than half the price?

It’s because Vitamix does just one thing, and they do it better than anyone else.

WhatsApp was just a messaging platform before Facebook acquired them for $19 billion US. Go Pro makes the best helmet mounted video cameras in the world. These companies stand out because they poured all of their limited resources into one big bet.

The typical business school of thought is to diversify and cross sell your way to a “safe” business with a balanced portfolio of products – so when one product category tanks, another line of your business will hopefully boom. But the problem with selling too many things – especially for a young company – is that you water down everything you do to the point of mediocrity.

Here are six reasons to stop being a jack-of-all-trades and start specializing in doing one thing better than anyone else:

1. It will increase the value of your business

When you sell one thing, you can differentiate yourself by pouring all of your marketing dollars into setting your one product apart, which will boost your company’s value. How do we know? After analyzing more than 13,000 businesses using The Sellability Score, we found companies that have a monopoly on what they sell get acquisition offers that are 42 percent higher than the average business.

2. You can create a brand

Big multinationals can dump millions into each of their brands, which enable them to sell more than one thing. Kellogg can own the Corn Flakes brand and also peddle Pringles because they have enough cash to support both brands independently, but with every new product comes a dilution of your marketing dollars. It’s hard enough for a start-up to build one household name and virtually impossible to create two without gobs of equity-diluting outside money.

3. You’ll be findable on Google

When you Google “helmet camera,” Go Pro is featured in just about every listing, despite the fact that there are hundreds of video camera manufacturers. It’s easy for Go Pro to optimize their website for the keywords that matter when they are focused on selling only one product.

4. Nobody cheered for Goliath

Small companies with the courage to make a single bet get a bump in popularity because we’re naturally inclined to want the underdog – willing to bet it all – to win. When Google launched its simple search engine with its endearing two search choices “I’m feeling lucky” vs. “Google search,” we all kicked Yahoo to the curb. Now that Google is all grown up and offering all sorts of stuff, we respect them as a company but do we love them quite as much?

5. Every staff member will be able to deliver

When you do one thing, you can train your staff to execute, unlike when you offer dozens or hundreds of products and services that go well beyond the competence level of your junior staff. Having employees who can deliver means you can let them get on with their work, freeing up your time to think more about the big picture.

6. It will make you irresistible to an acquirer

The more you specialize in a single product, the more you will be attractive to an acquirer when the time comes to sell your business. Acquirers buy things they cannot easily replicate themselves. Go Pro (NASDAQ: GPRO) is rumored to be a takeover target for a consumer electronics manufacturer or a content company that wants a beachhead in the action sports video market. Most consumer electronics companies could manufacturer their own helmet mounted cameras, but Go Pro is so far out in front of their competitors – they are the #1 brand channel on You Tube – that it would be easier to just buy the company rather than trying to claw market share away from a leader with such a dominant head start.

Diversification is a great approach for your stock portfolio, but when it comes to your business, it may be a sure-fire road to mediocrity.

Sellability Score

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

What’s so special about the million-dollar mark?

Republished with permission from Built to Sell Inc.

If you’re wondering when is the right time to sell your business, you may want to wait until your company is generating $1 million in earnings before interest, taxes, depreciation, and amortization (EBITDA).

What’s so special about the million-dollar mark?

The million-dollar mark is a tipping point at which the number of buyers interested in acquiring your business goes up dramatically. The more interested buyers you have, the better multiple of earnings you will command.

Since businesses are often valued on a multiple of earnings, getting to a million in profits means you’re not only getting a higher multiple but also applying your multiple to a higher number.

For example, according to our research at www.SellabilityScore.com, a company with $200,000 in EBITDA might be lucky to fetch three times EBITDA, or $600,000. A company with a million dollars in EBITDA would likely command at least five times that figure, or $5 million. So the company with $1 million in EBITDA is five times bigger than the $200,000 company, but almost 10 times more valuable.

There are a number of reasons that offer multiples go up with company size, including:

1. Frictional Costs

It costs about the same in legal and banking fees to buy a company for $600,000 as it does to buy a company for $5 million. In large deals, these “frictional costs” become a rounding error, but they amount to a punitive tax on smaller deals.

2. The 5-20 Rule

I first learned about the 5-20 rule from a friend of mine named Todd Taskey who runs an M&A firm in the Washington, D.C. area. He discovered that, in many of the deals he does, the acquiring company is between 5 and 20 times the size of the target company. I’ve since noticed the 5-20 rule in many situations and I believe that more often than not, your natural acquirer will indeed be between 5 and 20 times the size of your business.

If an acquiring business is less than 5 times your size, it is a bet-the-company decision for the acquirer: If the acquisition fails, it will likely kill the acquiring company.

Likewise, if the acquirer is more than 20 times the size of your business, the acquirer will not enjoy a meaningful lift to its revenue by buying you. Most big, mature companies aspire for 10 to 20 percent top-line revenue growth at a minimum. If they can get 5 percent of organic growth, they will try to acquire another 5 percent through acquisition, which means they need to look for a company with enough girth to move the needle.

3. Private Equity

Private Equity Groups (PEGs) make up a large chunk of the acquirers in the mid market. The value of your company will move up considerably if you’re able to get a few PEGs interested in buying your business. But most PEGs are looking for companies with at least $1 million in EBITDA. The million-dollar cut-off is somewhat arbitrary, but very common. As with homebuyers who narrow their house search to houses that fit within a price range, or colleges that look for a minimum SAT score, if you don’t fit the minimum criteria, you may not be considered.

If you’re close to a million dollars in EBITDA and getting antsy to sell, you may want to hold off until your profits eclipse the million-dollar threshold, because the universe of buyers—and the multiple those buyers are willing to offer—jumps nicely once you reach seven figures.

Sellability Score

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

How To Get a Big Company Multiple For Your Business

Republished with permission from Built to Sell Inc.

Big public companies trade at a significant premium over small businesses in the same industry because investors perceive big, sophisticated companies as a safer bet than small, owner-dependent companies.

Let’s take a look at the professional services industry. Although most consultancies are a small collection of experts, there are also a handful of big publicly traded professional services firms. Omnicom (NYSE:OMC) is a massive marketing services company with a market capitalization of around $18 billion. For all of 2013, Omnicom reported pre-tax income of $1.66 billion, meaning they are trading at around 11 times pre-tax income.

Smaller service businesses trade at much lower multiples. We know this because at our firm we offer The Sellability Score questionnaire which asks smaller business owners (our typical user has between $1 million and $20 million in sales) if they have received an offer to buy their business, and if so, the multiple of their pre-tax profit the offer represents. When we look at the professional services segment, we find the average multiple over the last two years was 3.81—almost three times lower than Omnicom.

When we isolate professional services companies with at least $3 million in revenue, the multiple being offered goes up to 4.97 times pre-tax profit, but it is still less than half of Omnicom’s 11 times.

And in case you thought this phenomenon was unique to the marketing services vertical, take a look at the IT services giant Accenture (NYSE:ACN). Accenture reported pre-tax income of $4.3 billion in 2013 and currently has a market capitalization of more than $52 billion, meaning they are trading around 12 times pre-tax profit, which is more than double the price we see being offered to smaller professional services firms.

How To Get a Big Company Multiple For Your Business

So how do you get a public company-like multiple for your business? One approach is to look for a strategic buyer. Unlike a financial buyer that is looking for a relatively safe return on their capital invested (which is the reason investors place a premium on big, stable companies trading on the stock market), a strategic buyer will value your company on how buying you will impact them.

Let’s imagine you have a grommet business predictably churning out $500,000 in pre-tax profit. These days, a financial buyer may pay you around 4 or 5 times earnings – in this case, roughly $2.5 million – if you can make the case your profits are likely to continue well into the future.

Now let’s imagine that a company that sells a billion dollars worth of widgets starts sniffing around your grommet business. They think that if they integrate your grommets into their widgets, they can sell 10 percent more widgets next year.

Therefore, your little grommet business could add 100 million dollars of revenue for the widget maker next year – and that’s just year one after the acquisition. Imagine what your business could be worth in their hands if they continued to sell more widgets each year because of the addition of your company.

The widget maker is not going to pay you $100 million for your business, but there is somewhere between the $2.5 million a financial buyer will pay and the $100 million in sales that the widget maker stands to gain next year that is both a good deal for you and for the widget maker.

Premium multiples get paid to big companies, and also to the little ones that can figure out how to make a big company even bigger. If you’d like to know how your company performs on The Sellability Score, simply complete the 13-minute questionnaire here at www.businesssellabilityaudit.com

Sellability Score

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

One Hidden Thing That Drives Your Company’s Value

Republished with permission from Built to Sell Inc.

You already know that your company’s revenue and profits play a big role in how much your business is worth.

Do you also know the role cash flow plays in your valuation?

Cash vs. Profits

Cash flow is different than profits in that it measures the cash coming in and out of your business rather than an accounting interpretation of your profit and loss. For example, if you charge $10,000 upfront for a service that takes you three months to deliver, you recognize $3,333 of revenue per month on your profit and loss statement for each of the three months it takes you to deliver the work.

But since you charged upfront, you get all $10,000 of cash on the day your customer decides to buy. This positive cash flow cycle improves your company’s valuation because when it comes time to sell your business, the buyer will have to write two checks: one to you, the owner, and a second to your company to fund its working capital – the cash your company needs to fund its immediate obligations like payroll, rent, etc.

The trick is that both checks are drawn from the same bank account. Therefore, the less the acquirer has to inject into your business to fund its working capital, the more money it has to pay you for your company.

The inverse is also true.

If your company is a cash suck, an acquirer is going to calculate that she needs to inject a lot of working capital into your business on closing day, which will deplete her resources and lessen the check she writes to you.

How To Improve Your Cash Flow

There are many ways to improve your cash flow – and therefore, the value of your business. One often overlooked tactic is to spend less on the machines your company needs to operate.

In the restaurant business, for example, there is an often repeated truism that it takes three bankruptcies at a single location before any restaurant can make money. The first owner of the restaurant walks in and – with all of the typical optimism of a new entrepreneur – pays cash for a brand new commercial kitchen complete with fancy stove, commercial grade walk-in coolers, etc., as well as all new dishware, pots and pans, thus depleting his cash reserves before opening night. Within a year, the restaurant owner runs out of cash and declares bankruptcy.

Then along comes a second entrepreneur who decides to set up her restaurant at the same location and buys all of the shiny new equipment from owner number one’s creditors for 70 cents on the dollar, figuring she has made a wonderful deal. But the outlay of cash is still too great and she too is out of business within a year.

It’s not until the third owner comes along that the location actually survives. He saves his cash by buying all of the equipment off the second owner for 10 cents on the dollar.

The moral of the story is: find a way to reduce the cash you spend on equipment, however you can. Can you buy your gear used on sites like eBay? Can you share a very expensive piece of machinery with another non-competitive business? Can you rent instead of buying?

Profits are an important factor in your company’s value but so too is the cash your company generates. We call this phenomenon The Valuation Teeter Totter and it is one of the eight key drivers of the value of your company. Curious to see how you’re performing on all eight drivers?

Sellability Score

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

10 Things That Make Your Business More Valuable Than That of Your Industry Peers

Republished with permission from Built to Sell Inc.

The value of your company is partly determined by your industry. For example, cloud-based software companies are generally worth a lot more than printing companies these days.

However, when we analyze businesses in the same industry, we still see major variations in valuation. So we dug through the data available to us from our partners at The Sellability Score and we found 10 things that will make your company more valuable than its industry peer group.

1. Recurring Revenue

The more revenue you have from automatically recurring contracts or subscriptions, the more valuable your business will be to a buyer. Even if subscriptions are not the norm in your industry, if you can find some form of recurring revenue it will make your company much more valuable than those of your competitors.

2. Something Different

Buyers buy what they cannot easily replicate on their own, which means companies with a unique product or service that is difficult for a competitor to knock off are more valuable than a company that sells the same commodity as everyone else in their industry.

3. Growth

Acquirers looking to fuel their top line revenue growth through acquisition will pay a premium for your business if it is growing much faster than your industry overall.

4. Caché

Tired old companies often try to buy sex appeal through the acquisition of a trendy young company in their industry. If you are the darling of your industry trade media, expect to get a premium acquisition offer.

5. Location

If you have a great location with natural physical characteristics that are difficult to replicate (imagine an oceanfront restaurant on a strip of beach where the city has stopped granting new licenses to operate), you’ll have buyers who understand your industry interested in your location as well as your business.

6. Diversity

Acquirers pay a premium for companies that naturally hedge the loss of a single customer. Ensure no customer amounts to more than 10 percent of your revenue and your company will be more valuable than an industry peer with just a few big customers.

7. Predictability

If you’ve mastered a way to win customers and documented your sales funnel with a predictable set of conversion rates, your secret customer-acquiring formula will make your business more valuable to an acquirer than an industry peer who doesn’t have a clue where their next customer will come from.

8. Clean Books

Companies that invest in audited statements have financials that are generally viewed by acquirers as more trustworthy and therefore worth more. You may want to get your books reviewed professionally each year even if audited statements are not the norm in your industry.

9. A 2iC

Companies with a second-in-command who has agreed to stay on post sale are more valuable than businesses where all the power and knowledge are in the hands of the owner.

10. Happy Customers

Being able to objectively demonstrate that your customers are happy and intend to re-purchase in the future will make your business more valuable than an industry peer that does not have a means of tracking customer satisfaction.

Like a rising tide that lifts all boats, your industry typically defines a range of multiples within which your business is likely to sell for; but whether you fall at the bottom or the top of the range comes down to factors that have nothing to do with what you do, but instead, how you do it.

Sellability Score

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

A blood pressure test for your business

Republished with permission from Built to Sell Inc.

When was the last time you had your blood pressure tested?

Taking your blood pressure is one of the first things most doctors do before treating you for just about anything. How much pressure your blood is under as it courses through your veins is a reliable indicator of your overall health; and it can be an early indicator of everything from heart disease to bad circulation.

Does it tell the doctor everything they need to know about your health? Of course not, but one powerful little ratio can give the doctor a pretty good sense of your overall wellbeing.

Likewise, your Sellability Score can be a handy indicator of your company’s wellbeing. Like your blood pressure reading, your company’s Sellability Score is an amalgam of a number of different factors and can help a professional quickly diagnose your company’s overall health.

Predicting Good Outcomes Too

When a doctor takes your blood pressure, they not only rule out possible nasty ailments; they can also use the pressure reading to forecast a healthy life ahead. Similarly, your Sellability Score can predict good things for the future. For example, based on more than 10,000 business owners who have completed their Sellability Score questionnaire, we know the average multiple of pre-tax profit they are offered for their business when it is time to sell is 3.7. By contrast, those companies that have achieved a Sellability Score of 80+ are getting offers of 6.6 times pre-tax profit.

In other words, if you have an average-performing business turning out $500,000 in pre-tax profit, it is likely worth around $1,850,000 ($500,000 x 3.7). If the same company improved its Sellability Score to 80+ while maintaining its profitability of $500,000, it would be worth closer to $3,300,000 ($500,000 x 6.6).

Are you guaranteed to fetch 6.6 times pre-tax profit if you improve your Sellability Score to 80? Of course not. But just like blood pressure, one little number can tell you and your advisor a whole lot about how well you are doing; and your advisor can then prescribe an action plan to start maximizing your company’s health – and its value down the road.

Heart disease is called “The Silent Killer” because most people have no idea what their blood pressure is. People can walk around for years with dangerously high blood pressure because they haven’t bothered to get it tested. The first step on the road to health is to get tested. If you have a great score, you can sleep well at night knowing you have one less thing to worry about. If your score is not where it should be, then at least knowing your performance can get you started down the road to better health.

Sellability Score

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.