A bit of preparation can produce a business valuation that any potential buyer will be happy with.
Most entrepreneurs like to know they can sell their business for a good price, but few actively plan for the event. Usually the sale depends on an evaluation of the income-producing power of the underlying business.
Yet few owners build a revenue and profit profile that supports an attractive valuation. With some planning, they could easily get three to four times more than originally expected.
Most businesses are copies of similar businesses in other locations, and they serve a local customer base. Generally, they have some local competitive advantage in one attribute of their business, although this is often simply a stable of loyal customers.
The potential buyer often has many similar businesses to choose from, or may even be indifferent to the type of business he buys. The bargaining power is mostly on the buyer's side, particularly if the owner needs to sell.
The business valuation will be substantially based on the current level of profit, and thus the owner who has to sell in a hurry without preparing the business for sale can be highly disadvantaged in the process.
Typical business valuations are based on a measure of sustainable net profit, after adjusting for the owner's salary and benefits. The future net profit may also be adjusted to compensate for replacing old equipment and other investments needed to provide an effective capability. The future income stream will then be adjusted down where revenue and profits are volatile or cannot be shown to be sustainable.
The value of the business will also be adjusted down where there are outstanding problems or risks, or if there is actual or potential litigation.
Where the owner is vital to the profitability of the business, the lack of a successor, a lack of adequate business-process documentation or inadequate performance measurements and reporting systems will cause the potential income to be adjusted down.
Protecting the value of the business can be achieved only if the entrepreneur puts in place systems and processes to assure the new owner that the forecast income stream is highly achievable and that the business has no inherent risks.
The first step is to undertake a vendor due diligence. This means the business will be examined from head to toe by professional accountants and lawyers to uncover any failures in compliance, reporting and control systems. They will advise the owner on how the business is best prepared for sale and for the acquirer's due-diligence process.
The next step is to build resilience into the business so that forecasts are more achievable. This is assisted greatly by building up recurring revenue.
Often, this can best be achieved by concentrating on the top 20% of customers. Where possible, they should be moved on to long-term agreements and you should seek opportunities to increase penetration of the accounts through cross-selling and loyalty schemes.
Less-profitable customers should be put on "low-touch" relationships to improve productivity and profitability. Supplier arrangements should be strengthened to ensure there is a continued supply of important components and services.
The whole business should then be examined for cost reduction.
Every dollar saved can have a multiplying effect on the sale value. One useful approach is to remove operations that add no value to the customer. Another is to use value engineering and activity-based costing techniques to highlight wasted resources.
The objective should be to increase the gross margin on every sale and reduce administrative and overhead costs, where possible, without hurting the business.
The final step is to set the foundations for growth. Since the sale value is based on the present value of the future income stream, increasing the growth rate of the business will directly affect the sale value.
The projected income from current products and services will already be built into the base sale value. The owner has to provide convincing evidence that the business can tap into assets and capabilities that are yet to be exploited.
These could be prototype products, new business relationships or untapped resources in the company. This could include new distributors, new alliance partnerships and innovations in products or services that will open up new markets.
Business valuation is often said to be more art than science, usually because many adjustments need to be made to account for uncertainties in the ability of the business to operate without the present owner.
At the same time, the revenue potential of the business is doubtful because the owner is not able to produce forecasts that have any degree of reliability.
Only by reducing the risks in the business, reducing the volatility of the business income, ensuring the business can be operated effectively without the previous owner and by building a platform for growth, can the seller maximise the sale value of the business.