It’s never too early to start positioning your business to sell at a premium valuation even if a potential sale is years away. The improvements needed to unlock the value of your enterprise can also yield supplemental benefits. To understand which improvements can add the most value, it’s helpful to think of how potential buyers size up businesses.
Cash Flow, Not Revenues
Buyers look for businesses that not only have high profitability but also are positioned to be sustained over the long term. To be clear, a buyer is typically not valuing your business based on a multiple of revenue, even if the numbers are impressive on paper. Rather, the buyer is valuing a business based on the sustainability of the company’s cash flows. A business with $5 million in sales and $1 million in earnings may be judged far more valuable than one with $10 million in sales and $500,000 in earnings, for example. While healthy profit margins differ by industry, businesses can improve their profitability by increasing revenues, managing costs and optimizing operations.
Price Appropriately
One way to maximize profit is to focus on gross profit margins, which includes pricing your products or services appropriately and managing the cost of sales. Many small businesses set prices conservatively for fear of driving away customers. The truth is that customers often tolerate higher prices, particularly if you provide a valuable product or service. Managing direct costs is the other side of the gross profit equation. By maintaining a healthy gross margin, the company has a higher likelihood of generating positive cash flows from each dollar of new revenue earned. One way to keep costs low is to seek out multiple suppliers of the materials and services your business needs. Having a diverse network of suppliers gives you the opportunity to identify the supplier that has the best price for materials or services needed.
Diversity Means Sustainability
Buyers will also want to see diversification when it comes to your customer base. A customer who accounts for an outsized proportion of your revenues may be a red flag for buyers. Should that customer walk away after you’ve sold the business, the new owner may struggle to replace the revenue. A diverse customer base reduces the risk of major revenue loss associated with one or a few customers and helps to provide sustainable revenues that buyers value highly. A strong brand and marketing strategy can also help diversify your customer base by raising your business’s visibility and differentiating it from competitors.
Decentralize Your Management
Another attractive feature for business acquirers is a capable, decentralized and experienced management team. Owners often sell businesses because they want to retire or move on to pursue other passions and opportunities. Leaving behind a good management team that is heavily involved in the day-to-day business operations gives buyers confidence that the business will continue to thrive after the sale.
Systems Beat Improvisation
Clear, effective systems and processes are another good indicator to buyers that a business is positioned to continue smoothly once the enterprise has changed hands. They also should allow the business to scale and grow efficiently, which, in turn, can lead to higher cash flows. Investing in technology and process development can help streamline operations and improve efficiency while also demonstrating to buyers that the business is forward-thinking and has a long-term vision.
The Value of Good Recordkeeping
The sale of a business is usually a six- to 12-month process. During that time, a potential buyer will want to go through your financial and operational records with a fine-tooth comb. The easier it is for the buyer to find the information they need, the more confident they will be in acquiring the business and the quicker the process will go. Meticulously documenting and organizing financial, legal, human resources and other information will help assure interested buyers that your business is well run. Documents that are typically requested during the sale process include financial statements, tax returns, procedure manuals and employee handbooks, accounts receivable aging reports, workers’ compensation claims and details of any pending litigation, among others.
Cleaning Up the Books
Two or three years before selling, businesses should tidy up their financial statements. That means professionalizing financial reporting, developing processes for analyzing sales and expenses and potentially conducting an external financial review or audit. It also means cleaning up the balance sheet by writing off bad inventory and bad debts and any other intercompany or personal loans that are irrelevant to the operation of the business. In addition, personal expenses paid by the business should be documented and recorded to ensure buyers can accurately gauge the true earnings of the enterprise. Understanding the true earnings of the enterprise, which includes adjusting cash flows for personal expenses, should make it easier for banks to assess the true business valuation. Greater clarity on true business valuation and sustainability of cash flows can make it easier for your buyer to get the financing needed to close a deal.
Improvements Shouldn’t Wait
Even if a potential sale of your business is years away, focusing on operational improvements intended to maximize its value can yield supplemental benefits. For example, businesses with higher cash flows may have greater access to capital, which can be used to invest in new projects, expand into new markets or even acquire other businesses. This can provide a significant competitive advantage over competitors in the same industry. Higher cash flows can also give a business an edge when attracting and retaining top talent because the employees are apt to perceive the company as more financially stable and promising for career growth.
To unlock the premium valuation of your business, improvements should be focused on increasing the sustainability of cash flows and reducing risk for prospective buyers. By focusing on these two items, you may also yield the supplemental benefit of higher cash flows in the future.
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