Increasing the Value of Your Business
By Alan Olsen
This blog deals with the process of increasing business value from the perspective of a buyer of the business. The real value of a business is the amount for which it can be sold, but maximum value is dependent not just on what a buyer will pay, but on selecting the type of buyer that will pay the most.
Privately owned businesses are typically sold on the basis of a multiple of earnings. Earnings for this purpose are expressed in a formula called EBITDA (earnings before interest, taxes, depreciation, and amortization). EBITDA is adjusted by adding or subtracting income and expenses that impact the owners of the business but not prospective buyers; e.g., excessive salaries and perks for the owners. The resulting adjusted number represents the ongoing earnings stream likely to be experienced by a new owner.
The multiple times adjusted EBITDA is the value of the business to the buyer. Inherent in the multiple is the risk level assumed by the buyer. Multiples may range from 2 to 10 for most private companies. The lower the multiple the higher the risk.
Where a company falls in that range depends not only on the risk level, but on the identity or characteristics of the most likely buyer. Generally, there are three types of buyers: strategic buyers, financial buyers, and related buyers. A strategic buyer, typically one in the same or similar industry, may pay a price based on a higher multiple because it can realize certain synergies when combining the two companies. A financial buyer will pay based on a lower multiple, and a related buyer, e.g., members of the management team, will pay based on a still lower multiple.
To increase the value of the company, owners will present their earnings as favorably as possible in terms of risk. Owners will emphasize the strong qualities of the company, but the significance of those qualities depend on the characteristics and perceptions of the buyers.
The first step in the process of increasing value is to identify the most likely buyers, figure out what drives value for them, and figure out what reduces risk. If you can improve those things, you can be on the path towards maximum value.
What are the elements that affect value? A partial list will include:
1. Growth rate
3. Geographic diversity
4. Quality of the management team
5. Research and development capabilities
6. Diversity of customer base
7. Strength of the employee group
8. Quality of operational systems
9. Vendor relationships
Focusing on a list this long may dilute your efforts to make substantial improvements. However, if you know what is most important to the buyer, you will probably be able to focus on a shorter list and have a bigger impact on value.
Finally, value is dependent on the state of the merger and acquisition market at the time of sale. Value can be increased if your personal situation allows you to sell when market conditions are favorable. Your personal situation may affect your timing. If you are emotionally and financially ready to leave the business and pursue other goals at a time when market conditions are right, you may be able to realize maximum value.