You can get much more for your business if you can prove that higher earnings are possible.
Few business owners give attention to building growth potential into their business prior to selling as they think that this will simply incur expenses which won’t be recovered in the sale value.
However, this is one way in which a significant increase in selling price can be achieved. While buyers won’t pay for uncertain outcomes, they are prepared to pay for highly probable increased profits.
We are all familiar with the impact of re-zoning on land values. You buy a block of land that is zoned for a single dwelling and spend 5% of its value on getting it re-zoned to a multiple dwelling site. In doing so you have probably increased the value of the land by 40% or more.
A buyer is prepared to pay the increased price because you have dramatically increased the probability of achieving a higher profit from developing the land. There is no reason why the same principle can’t apply to a business even though the skeptics will say that buyers don’t pay for potential that they have to realise. But let’s consider an example.
You have a business in Sydney with revenue of $10 million and an EBIT of $1 million and you value your business at 4 times EBIT or $4 million. You identify a similar business in Melbourne that could be purchased for $4 million and the combined business has anticipated synergies of $1 million from closing down one of the two warehouses and consolidating logistics activities.
By undertaking this acquisition you could increase your net worth by 4 times the saving, a new valuation of $8 million. However the buyer would be right in saying that the idea alone is not worth anything. How do you know they will do the deal? What if you lose key employees in the merger or are not able to integrate the logistics? So what are you going to have to do to push up the price of your business based on this proposal?
Valuations are based on anticipated future net cash flows. So in this case you would need to negotiate an option to buy the business, provide incentives for key employees to stay and provide convincing evidence that the business had the skills and capacity to integrate the logistics and warehousing functions. But if you could provide a business case that was able to show that the growth potential could be readily achieved, there is no question that this could dramatically improve the value of your business.
Higher valuations are paid for increased profits, profit growth and reduced risk, higher stability, more predictable and/or less volatile earnings. Since any investment decision is based on future earnings and not past earnings, it matters little whether the future earnings are projections of existing business or accessed through new endeavors. The key factor is the predictability of earnings.
Thus a business that can show how revenue growth can be reliably achieved and is able to demonstrate that it has the capability of supporting that growth, can include that potential profit in a valuation calculation. It all depends on the risk inherent in the numbers.
Similar results could be achieved by signing up new distributors, introducing new products, acquiring new intellectual property, introducing new internal processes and so on. The seller must demonstrate how the growth in revenue and profit will be achieved, provide convincing evidence of anticipated results and then show the business has the skills, experience and capacity of achieving the projected result. Evidence could come from prior projects, comparable businesses, industry benchmarks, sample trials and so on.
A business owner wishing to sell his or her business should seriously consider what a more capable and funded buyer could achieve. The current owner may not wish to increase their personal investment in the business or wish to take on the time commitment or stress of a larger concern.
However this should not stop them from creating growth potential that might appeal to the next owner. Growth does not have to be achieved to increase value; the business simply has to be put into a position where the new growth is capable of execution.
So before you put your business on the market, take a hard look at how it could be developed and put some effort into delivering this potential to the buyer. It will be worth the effort.
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