How to raise the selling price of your business
Achieving a great price for your business is unlikely to happen by accident. Jay Shaw says it requires a deliberate and on-going valuation-based strategy.
The day-to-day challenges of trying to build a profitable business make it easy to forget that its eventual sale can be an important source of financial return. The successful sale of a business can yield revenue equivalent to many years’ after-tax annual profits – and, for many, a vital retirement fund. Unfortunately, disruption caused by technology and wider socio-economic issues is lowering the value of many businesses, and making them much more difficult to sell. In the accounting industry, for example, the introduction of cloud-based IT and outsourcing solutions has lowered entry costs considerably, and with them the price buyers are willing to pay for existing practices. For practices further affected by rural-urban migration and ageing populations, a buyer may not even exist.
Similar challenges exist in many other industries. However, there is always likely to be strong demand for well-run, profitable businesses that can be transferred to a new owner with minimal disruption. Such businesses happen by design, because the owner consistently reflects valuation considerations in his or her business strategy. This is an important mindset, because the objectives of increased shorter-term profitability and long-term value may not always be compatible.
A case study
Terry (fictitious name) owns a small, profitable business selling bespoke voice, video and data solutions. His business generates revenues from two sources: equipment sales, including video conferencing systems and AV suites; and telephony sales, including revenues from line rentals, call charges, and support. Equipment sales are typically one-off, but deliver higher margins, while telephony sales have lower margins but provide recurring revenues. To improve short-term profitability, the recent focus of Terry’s sales team has been on equipment rather than telephony sales; these now contribute the majority of total revenue.
A large competitor recently approached Terry to acquire his business. The potential buyer was willing to pay a significant multiple of around ten times profit for the recurring income streams, as these would enhance its existing business. In contrast, it placed almost no value on the profits generated from equipment sales, having its own successful presence in that market segment. Terry and his buyer were unable to agree a deal. Negotiations with the buyer made Terry appreciate the importance of balancing both profitability and valuation considerations; to become an attractive acquisition target he would need to restructure his business.
The value of researching your buyer market
Successful businesses are market-led. Their owners understand how their market is structured, who their customers are, and their competitive landscape. This enables them to focus on profitable market areas and adjust their business and offerings in response to changes in their market. The same principle of ‘know your customer’ applies when it comes to maximising the selling price of your business. A business evaluation specialist can help you conduct expert market analysis to identify likely buyers for your business, and why they might want to buy.
Some purchasers will be prepared to pay more than others: business sales evidence shows that purchasers gaining strategic benefits from acquisition (often existing competitors) are likely to pay higher multiples than purely financial buyers. A purchaser wanting to buy themselves a job may also be prepared to pay more.
Once you identify purchasers who might pay a premium for your business you can use this information to make it more attractive to them. When the time comes to sell, you can also use this knowledge to justify a price in excess of any industry ‘rule of thumb’, which could significantly undervalue your business.
Why you need to act now
Optimising your business for sale takes time, so you can’t afford to wait until you are ready to put it up for sale. If selling your business is your ultimate exit plan, you should begin your buyer-market research now, and build the insights you gain into your business strategy. In Terry’s case, an earlier market analysis could have led him to focus on increasing recurring revenues, resulting in a profitable sale. In other situations, identification of an existing employee as a likely purchaser could achieve a desirable sale price without the need for a costly external process.
Making your business more attractive
Once you have identified potential buyers and their motivations, you may need to make changes in your business strategy. For most businesses this means taking steps to maximise the intangible value that can be transferred to a buyer (the ‘business goodwill’).
Business goodwill is based on the ability of your business to generate future economic returns. It differs from goodwill that is personal to the owners, which cannot be readily transferred and so is unlikely to have any transfer value. High levels of personal goodwill are often seen in small specialist businesses that depend on the owners’ personal expertise, experience or contacts. For those businesses, there might simply be no buyer. It is important to understand if this is the case for your business, so you can pursue a focused strategy based solely on profitability.
However, for a large number of companies business goodwill does exist, and can be enhanced whilst maintaining profitability. For example:
· A decision to move premises may deliver a higher value because the new location is of greater interest to potential buyers.
· Updating contractual documents in line with accepted industry practice is likely to make it easier to integrate one business with another.
· As in Terry’s case, the key issue might be more structural, such as adjusting the sales mix between recurring and non-recurring sales to attract increased valuation multiples.
All of these business decisions are based on a clear understanding of your potential buyers.
Like any other product or service, a business exists within a market. When you view your business in that light, and get a clear understanding of the motivations of the buyers in that market, you can identify specific steps to achieve an increased sale price – and perhaps a more comfortable retirement. It’s essential that you conduct this research well in advance, so you can structure your business to balance long-term value and ongoing profitability.
Jay Shaw is a partner at Forensic Advisory Services, a specialist practice undertaking independent share, business, and intangible asset valuations. Contact him at [email protected]or nz.linkedin.com/in/jayshawnz