This is for every business owner
At face value, this article is for those of you who are actively considering selling your business. Or at the very least interested by what it’s worth.
What I try to demonstrate in this article is that business valuation should be central to the thoughts of any business owner. Whether you’re thinking of selling or not.
That’s because the 7 Factors that drive up business valuations involve taking certain actions. And these actions are precisely what you want to do if your ideal end-result was franchising, handing it on to the next generation, selling – or indeed keeping it for yourself to enjoy. All of these options require the same approach.
The vast majority of businesses have 1 fatal flaw
The Office of National Statistics estimates that c76% of the 5.9m registered businesses in the UK are owner-operated. (One man bands in old money). If you turnover more than £1m you’ll be in the top c3.5% of all UK businesses. Plot that on a chart and it’d be the definition of a hockey stick curve.
And this points to the fatal flaw that most small businesses have.
They are somewhere between ‘way too’ and ‘completely’ reliant on their owners. So if I were to give you a cheque for your business, you’d disappear with the money and I’d be left figuring out where everything is and how it works.
Valuations don’t lie
The vast majority of businesses are never sold as a going concern.
According to ValueBuilder, only 20% of businesses are listed for sale and of those only 20% are sold. That amounts to just 4% of the total – which is a scary statistic in its own right.
For those that do sell, the price paid for that business is most frequently expressed as a multiple of historic EBITDA (Earnings Before Tax Depreciation and Amortisation). For most businesses is very close to Net Profits.
The average multiple for a business sold / acquired in the UK is 3.4x EBITDA. So, a business making £250k of EBITDA would in theory be valued at £850k.
When you dig a little deeper into this, things get more interesting / illuminating.
The average multiple paid for a business with a designated senior management team (ie where the business is not reliant on the owners) is 6.8x. And the average multiple for a micro business (defined as less than 10 employees (which is unlikely to have designated managers) is 2.2x. By the time you get down to our trusty one person bands, the multiple will in practice likely be less than 1x.
Think about that for a moment.
The ‘payout’ for all that blood, sweat and tears amounts to retiring 1 year earlier. All that innovation, problem-solving and weekend stress is valued at less than a year’s dividends.
Some sellers choose to get a bit more in exchange for carrying on in the business for another year or 3. It’s an option – but I could introduce you to plenty of people who have come to regret that choice. It’d be like watching someone else parent your kids.
What’s the solution?
It’s important to realise that valuation is merely a starting point. It’s an average because it represents a range.
A friend of mine sold his hospitality business for 10x earnings and a colleague sold his transport logistics business for 44x earnings.
The key for you is to understand why this is. What are the factors that influence where on this range your business will sit.
There are 7 factors that influence the potential valuation of your business.
The size of a business does play a part in a business valuation as does the industry and asset base.
If you view this as the starting point of the range, you then have 7 factors – that you can influence as the owner – which determine where on that range your business sits.
1 Financial Performance
What a buyer wants to know is whether the business requires cash to grow – in other words if there is a cash gap at any stage between the order being taken and paid for in full. They want to know how the underlying gross margins compare to the industry average; if the business is getting proportionately more profitable as it grows; what the best performing marketing channels / products are. The list goes on.
Being able to demonstrate what these numbers are – and have been – increases visibility and therefore reduces risk.
Creating your own dashboard will improve your performance as the MD – and make your business more valuable to others.
For a detailed explanation of how to create a dashboard for your business, click here.
2 Growth Potential
Depending on the type of business you own this could refer to production or your team – and having a checklist (detailing best practice) for both will help your performance and increase the worth of your business in the eyes of others.
The big one though is marketing. Daniel Priestley’s quote that every business is a marketing strategy with a product attached should carry a lot of weight with business owners.
Or as Brad Sugars puts it: marketing is maths – it’s just about buying leads.
Imagine having a document which detailed every marketing channel you’d ever tried: best practice, leads generated, customers generated, cost per lead, investment, Return on Investment – every month, over time. For SEO; PPC; tele-marketing; trade shows – whichever of the 70-odd marketing channels you’ve tried, tested and proven.
In an instant the buyer would know how to grow your business in line with their ambitions.
Now that would be valuable.
3 Customer Score
As Jonny Wilkinson said “You won’t fluke success” and this absolutely applies to customer service.
As businesses grow and people become stretched, the customer feels the impact and maybe even voices a complaint. No-one thinks they give bad customer service and no one thinks they’ve got an ugly baby – but that’s not what the impartial feedback tells you.
Customers feel like they’ve had a great experience for a reason. It happens when employees take ownership, promises are kept and expectations met.
None of this just happens. It requires systems, training and a great culture.
It requires the consistent effort to ask for feedback, understand the criticisms and act on them. And then even more to enshrine them in best practice.
Imagine running a business that not only had a great reputation with your customers, but also had a document that detailed every aspect of how they did it.
4 Recurring Revenue
This is great if your business runs on a subscription model – something like Hubspot or Xero. You’ll acquire customers, you’ll lose some and between the two you can monitor and try to improve the Average Lifetime Client Retention in Months. If say that’s 36, someone can buy your business and have cashflow visibility for c3 years.
But what if in your business customers buy 1 thing at a time (plumbers, clothes retailers etc) or harder still, are only ever likely to purchase once (architects, kitchens etc)?
Maintenance contracts can help but that’s not always applicable.
But – one of the hidden benefits of these ‘one at a time’ / ‘one off’ businesses, is they tend to lend themselves to strategic referral partners. And if you can demonstrate a successful strategy for fostering and nurturing these it will be valuable to others.
5 Monopoly Control
In practice, for most businesses, monopolies don’t exist – and for the rare few, they won’t exist for long.
And so in practical terms, this is the degree to which you are the automatic choice in your market place. Some people would refer to this as your brand value.
You’d tackle this one by asking some basic and tough questions:
“In what specific ways are we better than our competition?”
“In what specific ways are they better than us?”
“How do we compare to them in the eyes of our ideal prospects?”
And perhaps most importantly “What promise can we make that our competitors would fear to match?” (which you could turn into a guarantee.)
If you ask yourself these questions honestly and genuinely, it will lead you down a path which if you stay on it will improve your product / service, your team and your business.
This will show up in your customer satisfaction scores, testimonials and awards. (Not to mention many other areas of your business: repeat business, referrals, staff retention etc etc)
6 Autonomy from Risk
If you define ‘risk’ as the likelihood of something bad happening, this section refers to reducing the impact of the bad thing happening as much as reducing the odds of it impacting you.
You’ll have no doubt heard of the Pareto Principal, and most businesses have a ‘touch of the Pareto’ about them.
That might be the amount of business you get from a particular client, product, or market. It might be an over-reliance on a particular marketing strategy. Or it might be the importance of a particular employee, manager or indeed you.
Whatever the example, being overly-reliant (dependent) on anything or anyone is risky. Minimise the reliance, minimise the risk, increase the value.
7 Business Systems
If there’s one single stand-out area that differentiates businesses where growth is more under control and those which feel more chaotic – it’s systems and software.
Whatever industry you’re in there will be systems and software that can increase efficiency at the same time as actually improving the customer experience.
As always, you’ll be spoilt for choice which can be confusing. I’ll write about this in a separate blog as the return on your investment of time and money will be handsomely rewarded. In your day-to-day working life as well as via the valuation.
We keep a database of solutions that have worked well for different industry types to help with this.
Here’s the real reason all this is crucial for you.
The real kicker here is to stop and think what your business would feel like to own and run if you spent serious time and budget optimising these factors to the very best of your abilities.
How would it feel to have a significantly improved, reliable marketing pipeline of potential new customers?
How much easier would it be to sign up the best customers for you?
How would it feel to have a team that is more organised, engaged and innovative? Where they want to take on more responsibility so you no longer feel like the only one who cares enough to solve problems.
All the steps you’d take to increase the valuation of your business will also lead to your business being much more rewarding to own. Not just in terms of profits, but also personal satisfaction and quality of life.
It’s also exactly what you’d need to do if you wanted to successfully franchise your business; hand it on to the next generation of your family or indeed your employees – without encumbering them with a joy- and-money-sucking monster.
Want to get your own business valued? Click here to book an initial 40 min call.
(NB: statistics quoted are from one of Dept for Business, Energy and Industrial Strategy (BEIS), Office of National Statistics, US Small Business Association.)
