In an earlier post, I discussed the different reasons a business owner might do a business valuation. There are many great articles that describe different ways to sell your business, including one by the Wall Street Journal. In this post, I'll discuss the different ways a buyer might value your business for purposes of sale.
When you think about business value, most potential buyers think through the following general questions:
- Will the business continue to generate excess cash flow (as often times, this is what a buyer is looking to acquire – future cash)?
- By combining this business with another business, can we create additional value (e.g. 1+1 = 3)?
- Can I cut costs with this business in order to increase profits / value?
- Is the business dependent on any one person / group of people?
- What are the business's tangible assets worth – and will they need to be replaced in the near term?
While there are many adjustments and factors to consider when determining the value of your business, generally, I've found that a financial buyer (meaning someone interested in future profits, not necessarily intense growth) will pay anywhere between 3.5 – 7 X profits (EBIDTA) or .6 to 1.2 X revenue. Generally businesses with lower gross margins / tangible product costs sell on the lower range, businesses that have higher gross margins will sell on the higher end of these multiples.
Given this range, a strategic buyer (think larger company looking for market share or your particular niches skill / product) will pay between a 5% - 20% premium on these values in recognition of the potential growth in future value. An internal buyer (e.g. your management team / family) will pay around 15% - 25% lower in recognition of the equity they helped you build in the first place (you don't want to make the business cash strapped in order to fund your buyout).
Key determinants of value:
- A competitive advantage based on differentiation (e.g. you truly do it better in a sustained manner – and thus have a higher profit margin) OR
- A competitive advantage based on superior use of assets and logistics (e.g. your supply chain is efficient and you rapidly turn over assets, thus meaning low borrowing costs and good liquidity – think Dell Computer having a computer sold and paid for before it's even assembled).
- Management team that can function at a high level without you.
- Established metrics and reporting
Again, while there are many others, these are the keys to maximizing value.