Increase Your Business Valuation
No matter the reason for wanting to sell one’s business, every South Florida business owner wants to maximize their purchase price. If possible, many business owners may increase their valuation by taking long term steps that will result in buyers generally placing a premium on the business valuation. Although these steps may result in short term disruptions or even less cash flow, the long term effects on the business valuation will be profound. Let’s explore why a business with steady and growing profits, transparent financials, a diversified customer base, and a relatively absentee owner will result in a higher business valuation.
Stable and Growing Profits
Many South Florida business buyers value stability and steady growth more than any other attribute when evaluating businesses for sale. Indeed, a wide array of buyers prefer businesses without customer concentration risk, which is when a customer represent more than 10 percent of total sales. A stable and steadily growing business without customer concentration risk is more likely to be seen as a safer investment. In particular, a business with recurring revenue or a business model based on recurring customer payments (such as a subscription model) will receive even more of a premium. Of course, many businesses may simply not be able to transform themselves into a stable grower with recurring revenue. But often times it is possible to change one’s business model so as to increase the business valuation.
Changing Business Model to Receive Higher Business Valuation
- Let us suppose that Bob’s Plumbing Company generates $500K of sales per year and has an adjusted owner benefit (or true economic profits) of $150K per year.
- Let us also assume that the $500K of sales is largely from new construction or remodeling projects which are referred by a few general contractors with whom Bob is friendly.
- Bob is not likely to receive a high valuation for his business because of the very high customer concentration risk and because the sales are largely from non-recurring remodeling or new construction projects.
- Bob is much better off changing his business model by focusing on service revenue from repeat residential or commercial customers.
- This way, Bob will not largely rely on referrals from a handful of general contractors, and while broadening and diversifying the customer base.
- This should result in steady and repeatable business for many years.
- Even if Bob’s owner benefit decreases (to let’s say $100K per year) as a result of this short-term change, he will most likely receive a higher business valuation in the long term.
Transparent Financials
A major step in preparing one’s business for sale is obtaining a clear and transparent set of financial records. In the short term, this can usually be accomplished by meeting with one’s accountant and obtaining historical tax returns and accurate profit and loss reports for the past three years. If, however, such accurate records do not exist then this will diminish the business valuation. Common reasons for not having accurate tax records include unrecorded sales, disorganized or inaccurate expenses in the tax return, and tax returns that simply do not reflect the reality of the business.
Transparent Financials Leads to SBA Lending
- No business owner wants to pay more taxes, but in order to get the best purchase price for their business, having accurate financial records is essential.
- Without accurate tax returns and transparent financials, it will be nearly impossible for a business buyer to obtain a Small Business Administration (SBA) backed loan.
- The key to qualifying for an SBA backed loan is for the purchase price to match the appraisal that the SBA will employ to evaluate the business.
- As one may imagine, this appraisal process largely revolves around the financials that the business provides.
- Without transparent financials that accurately reflects the purported sales and profits of the business, the appraisal will almost certainly be below the purchase price.
- If buyers needing external financing are thus eliminated from the pool of potential buyers, then the valuation of the business will be greatly diminished.
- As dictated by the law of supply and demand, less potential buyers (or demand for the purchase of the business) means a lower price.
- Even if it takes two or three years, a business owner may be better off by filing accurate tax returns (and paying more in taxes) in order to get premium value for their business.
Absentee Ownership
An absentee-owned business means that the owner has no day to day operational role. This is very rare and will certainly result in a premium valuation. There are, however, degrees of absenteeism where owners are more passive than others. In general, the less active a role that the the owner has in the business, then the higher the valuation. Conversely, a very active owner may necessitate the buyer incurring costs of having to replace the owner (or their family members) with paid employees or their own labor. Such costs will eventually detract from the valuation of the business. Moreover, if the retention of key customers or employees is dependent on the special skills or personality of the owner, then the business valuation will also suffer. Even if the owner has to change the business model and increase expenses by hiring more management in order to reduce their own role, such steps will be rewarded in the long term with a premium business valuation.
A business with steadily growing sales and profits, low concentration risk, transparent financials, and passive ownership will sell for a higher valuation.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.