Do you want to get rich quickly?
Very simple: Buy a business for its actual value, and sell it back right away for what the business owner values it.
Many business owners overvalue their own business (after all, isn’t your business the most beautiful baby in the world?). What do you need to pay attention to in order to make sure that you get the valuation you want when the time is ripe?
Looking at your business through the eyes of a buyer
Regardless of whether you want to sell your business (or pass it on to your children) in one or in 100 years, looking at your company through the eyes of a buyer can help you identify your top priorities to develop a stronger business – and ultimately get the valuation that you want.
Based on experience, readings, and many conversations with experts in the business of buying and selling companies, I have identified 10 key points that can derail your company value. There are obviously many more – I selected these 10 because of their considerable impact on business valuation. The goal of this article is to generate self-reflection through two questions:
- On a scale from 1 through 10, how is your company performing on each of these 10 points below?
- Which of these points should be your top priority for improvement?
What defines the value of your business?
“There are two pieces to valuing a business, says Mark Campbell with Scout Valuations, a business valuation firm specializing in mid-sized companies. The first is the cash flow it can generate. The second is the risk associated with generating those cash flows in the future.”
This article is therefore structured in 3 parts:
- Forward-looking (growth potential of your cash flow).
- Backward-looking (past and present cash flow).
- Risk to your cash flow.
10 things that can hurt your business valuation
Lack of healthy growth potential
1. Unclear positioning and lack of differentiation, which makes your long-term growth potential questionable. This is due to a poor understanding of:
- Who your core customer is.
- Which fundamental problem you solve for your core customer.
- What your competitive advantage is in solving this problem – in other words: what makes you special, unique, and better than your competitors in the eyes of your core customer?
2. Lack of focus on your core business (“Whatever the client asks, we deliver”), due to a lack of clarity or discipline on your core purpose. Because these distractions take up considerable management’s attention and energy, they hinder your ability to grow faster and with less pain. In Built to Sell John Warrillow explains: “Don’t generalize; specialize. If you focus on doing one thing well, the quality of your work will improve and you will stand out among your competitors.”
3. Lack of standardization of your product/service offering. If every client receives a tailor-made solution, growing your business generates limited economies of scale. As Warrillow puts it, “as long as you customize your approach to solving client problems, there is no scale to the business and your operations are contingent on people. Since people can come and go every night, your business will not be worth very much.” From a buyer’s perspective, standardizing your solutions makes it easier to train new people when needed, and makes your business much more scaleable.
4. Lack of innovation / new product pipeline to improve your competitive advantage and better solve your core customer’s fundamental problems in the future. “Would you buy a business, even profitable, where you see a limited future [because of the lack of innovation]?” asks business broker of mid-sized companies David Humphrey in Think Like a Buyer.
Poor cash flow
5. Over-commoditization, due to a poor understanding of your profit and cost drivers and of your competitive advantage. This puts your sales price and margin under pressure. As Warrillow puts it: “Businesses that only compete on prices are rarely interesting to buyers.” If the main reason you gain new business is your price level, you have an issue – unless your production / delivery process is structurally less expensive than your competitors.
6. Poor quality cash flow, like:
- Negative and/or slow-growing EBITDA in the last few years.
- Non-recurring revenue streams. The more repeatable your business, the more predictable it is – and the higher its value.
- Slow-paying customers. How can you adjust your business model to have your clients pay sooner in the process, fully or partially? This would help grow your business, but would also help reduce the risk on your cash flow – and hence increase its value.
7. Over-reliance on the business owner with unclear succession plans:
Many business owners think that they are indispensable and get nervous when on vacation – that alone makes a potential buyer very nervous. Build a business that runs without you. Business owners sometimes tell me that they will delegate more once they reach $X in revenue and can hire more/better people. There is always a good, rational-sounding reason to retain control. The reality is: it is never too early to think about how to become more dispensable in your business.
This is even more problematic if only you can reliably generate new business in your company. Here is how this vicious circle goes: every one of your clients loves talking directly to the business owner, which drags you to the epicenter of your operations, which increases the customers’ reliance on you, and so on.
You need to break this cycle and extract yourself from being personally involved in most customer relationships. If your company is larger than $1M and you are still the main salesperson in your business, you need to rethink your role. Warrillow quotes an entrepreneur who successfully grew and sold several businesses: “Your job is to hire salespeople who sell your products and services so you can spend your time selling your company.”
8. Lack of management depth, of competent team and/or high employee turnover.
“When senior management wants to sell and retire, a layer of experienced lieutenants can make a significant impact on the buyer’s perception of value,” writes Humphrey.
9. High customer / supplier concentration.
“Nobody wants to buy a business that relies too heavily on one client. Make sure that no client makes up more than 15% of your revenue,” says Warrillow. If you operate in an environment with only a few customers, “the key is to alleviate that risk as much as possible. If those few customers are all under long-term contracts, a buyer will have more confidence in future cash flows and will likely pay more,” says Campbell.
10. No reliable financial information or accounting system and/or lack of internal financial/operational control.
“The more a buyer trusts your numbers, the more interest they will have in buying your business,” according to Humphrey. Working with a reputable CPA firm helps build this trust.
Do you want to find out more? Read the full article here: 10 ways to hurt the value of your company – Ambrose Growth | Business Coaching