Growth in the value of a business is a goal of many business owners. However, not all businesses increase in value, and creating value can take time and hard work. A business could increase its revenue but not profitability, and even if profitability increases, the net saleable value of your business may not increase along with that profitability.
Saleable value is the value a buyer is willing to pay for a business. It’s based on the income a buyer can assume in the future, not what was generated in the past, as well as the inherent risk of generating that future income.
Past income is only used to predict future income, but future income isn’t always going to be similar to the past.
Economic conditions, anticipated changes in customers after a potential sale, changes in management, and other risk factors can affect future income. In addition, multiples paid on those earnings can change over time based on financing available, buyers and sellers in the market, and investor perceptions on the risks affecting the business.
So how can business owners work today to increase the “future” value of their business? One of the key ways to increase value other than increasing revenue and profitability is by decreasing the risk factors that buyers will consider when establishing a purchase price. So how can a business owner reduce the risk a buyer would consider impactful to future results?
Value in a business is primarily driven by risk and return. Higher income and future growth potential = higher value. But higher risk = lower value. Risk can stem from issues like customer concentration, industry conditions, labor issues, the condition of your equipment and a variety of other concerns.
Understanding where risk exists and creating a plan for how to address those risk is key to value creation in a business. For example:
- Management: Think about how much of the business hinges on your involvement as an owner. Do you hold key customer relationships? Are you the only one who handles bidding? Will essential employees quit when you leave? Over-dependence on the owner jeopardizes the buyer’s ability to sustain business success.
- Staffing: How many of your employees are near retirement age? What are the turnover trends in your business? Is your labor force legally and properly employed? Buyers know the talent market is tight, and they’re looking for a stable workforce.
- Downtime: How often is your machinery breaking down? How long do you have to wait for essential parts or a repair technician? Consider whether new equipment, or a new in-house maintenance effort, would reduce downtime risk for a buyer.
- Customer diversity: Imagine two companies with equal revenue, equal income, equal EBITDA. Now imagine one of those companies has 50 customers; the other has just two. Which business would you rather buy? Evaluate strategies to diversify your customer base and reduce customer concentration.
In addition to reducing risk, increasing profitability will have an impact on future sale value. Understanding what is driving your company’s profitability is key to increasing that profitability. Again, that can often be harder than it sounds.
For example, our manufacturing group ran an analysis for a client that was working hard to serve their number one customer and keep that account happy. But by digging deeper, they found the margin on that work was practically zero.
At that point, the manufacturer might have been better off focusing on different, higher margin customers. By shifting their focus to other customers, the company may decrease revenue but grow profitability — and improve customer concentration issues at the same time.
There are different ways to grow capacity. One way is to let go of work from low-margin customers. Other strategies include better utilizing your space or equipment. New technology can add capacity by auto-ordering materials, automating machine scheduling or reducing the staff time necessary to complete key tasks.
As you think about selling, talk to your advisors about capacity improvements. Consider where it makes sense to make your own capital investments and where you’ll leave those improvements to a buyer. Either way, it’s a good idea to have a clear plan for how the business could evolve to meet customer demand.
Keep building, keep dreaming
Part of selling a business is selling its growth story. You want to paint an exciting picture for the years ahead. Help buyers see a vision for what the company could be, versus what it is today. In other words, you need to keep that entrepreneur’s hat on — keep dreaming, planning and building toward that next level — even as you think about leaving your business.
Boost business value by planning ahead
A few years before you sell your business, it’s helpful to reframe how you think about growing value. Instead of evolving the business so it fits your goals, it’s time to start developing a business with your future buyer in mind.
With some advance planning, you can make reasonable, achievable shifts that not only improve your company’s salability but also can increase the price buyers are willing to pay.
Wipfli can help you build business value
Wipfli’s team can provide a business valuation and salability analysis designed to help you strategize for a future exit. We’ll help you understand how various deal structures could impact your net cash after a sale. We’ll also identify various value drivers that could help you attract more buyers and maximize your sale value. Learn more on our business valuation services or check out these additional articles: