Selling Growth Business
A growing business is characterized by a demonstrable record of multi-year historical increases in its sales and profits with more expected growth to occur in the future. Since businesses are primarily valued as the present value of its future income stream, growth businesses with higher expected future profits are valued at a premium compared to non-growth businesses with expected future profits that are stagnant or even declining. This is visibly apparent in the stock market where publicly traded companies with high growth prospects are valued at higher multiples of their present earnings compared to non-growth companies. Similarly, in the realm of small business sales, companies with a proven business model and competitive advantages that facilitate future growth will receive a premium valuation when it comes time to sell. Experienced business brokers will showcase the expected growth along with reasons why the business will continue growing to justify a premium valuation.
Premium Valuation for Growth Businesses
The most important factor when valuing a business is the expected income stream expected by a buyer from the business after the sale. The median valuation multiple for businesses is about 2.5 x the current profits (or adjusted owner benefit) generated by the present owner. This means that the buyer will expect to receive their investment back from buying a business in about 2.5 years. When the earnings of the business are reasonably expected to increase (based on its current growth rate) after the sale, however, the time it takes a buyer to recoup their investment lessens considerably. For example, a business generating $500K/yr in profits and expected to grow 20% per year allows a buyer to recoup their investment back in less than three years even while paying 4 x the current profits (or $2M). The key to selling a business for this growth premium is showing how the past history of growth for the business will continue in the future for the buyer.
Reasons Why Businesses Grow
- A business may grow due to a number of reasons including the overall population and demographic trends in its market, the long term secular trends in its industry, and its company-specific competitive advantages that drive increased market-share.
- Business owners in South Florida are fortunate to be doing business in a market which has grown its population base remarkably well within the past generation.
- The population of Palm Beach County has grown by 40% since 2000, and its median income is in the top 25% of the national average.
- The growing South Florida area provides a significant boost to the growth prospects of many businesses, which in turn will increase their business valuations.
- Additionally, businesses may grow due to the long-term secular trends of an industry which transcend an ordinary business cycle and has to do with a fundamental shift in consumer behavior or technology.
- A business that takes advantage of such a trend is likely to get a significant tailwind in its future growth trajectory, and should receive a premium valuation multiple as a result.
- Most recently, the post-Covid boom in the home services industry created by a desire for many consumers to ‘nest’ and upgrade their homes (helped by lower interest rates) led to substantial secular growth for many industries in the home remodeling, plumbing, and HVAC markets.
- Lastly, businesses grow by taking market share from competitors due to its competitive advantages.
- The competitive advantage of a business may be a more cost-effective way to produce a product or service, or by providing products or services at a level of quality that is difficult for competitors to match.
- As business valuations change over time, a company’s competitive advantages over time may strengthen which will serve to enhance its valuation.
Sustainability of Growth Important for Buyers
Whether the growth of a business is attributed to market-specific, industry-specific, or company-specific factors, buyers focus on the sustainability of the growth. The key to convincing buyers that the growth rate of a business is sustainable generally has to do with the seller’s role in the business. The greater the role of the seller in driving the growth of a business by virtue of their personal characteristics, expertise, or contacts, the less likely growth will be sustained in the future after the sale. On the other hand, if a seller is relatively absentee from the day to day operations of the business, and the business model (including its trained staff, strong supply chain, and unique product or service that competitors can not easily replicate) rather than the seller is responsible for growing the business, then buyers are likely to conclude that the growth will be sustained after the sale.
Growth Should Increase Net Margins
A key way in which many buyers gauge whether the growth rate of a business is sustainable is the extent to which operating margins are increasing over time. Operating margins, or return on sales, measures the percentage of pre-tax profits (or operating income) divided by gross sales. Operating leverage refers to the degree in which a business can increase its operating margins by increasing its revenue. This may come about when a company spreads out its fixed costs over a higher revenue base, as well as when a company realizes cost-savings and efficiencies from scaling its operations. A business that has strong operating leverage demonstrates a superior business model that can keep growing profitably over time.
A growing business that for demonstrable reasons is expected to keep growing in the future should always sell for a premium compared to a stagnant or declining business. For business owners, it is imperative that a professional business broker emphasize to prospective buyers why the business is growing and why the business will remain growing after the sale. This way, the premium valuation is justified and will result in the best possible purchase price of the business.
Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.