When it comes time to sell your company the first question you will likely ask is “How much is my company worth”? And that will be followed by “Can I do anything to increase its value before I put it on the market?”
The answer will vary based on your industry, stage of growth, and past performance along with several other factors. It’s important to understand these factors and how your business will be valued by your potential buyer. In addition, the sooner you put a plan in place to build value into your business that is aligned with buyer preferences the more likely you are to achieve an optimum outcome.
What you need to focus on
Building value starts with knowing the current value of your business. The importance of being objective about it cannot be stressed enough. Business owners struggle to see their business the way investors do, because it is a large part of their identity. To pinpoint the best asking price for your business, you’ll need to narrow your focus (temporarily) and see your business from the investor’s point of view. They want to know the kind of numbers they can expect from your company. They’ll also want to know how your company has achieved these numbers.
Models buyers use to estimate value:
There are many formulas used to determine a business valuation. A simple Google search on the subject returns thousands of articles. However, they can all be summarized into three models that are the most common:
EBITDA * Multiplier
EBITDA = Earnings before interest, taxes, depreciation, and amortization. This is a measure of your profitability and will indicate the future cash flow expectations for the buyer. The multiplier is based on factor such as financial history, future projections, addressable market, and industry specific KPI’s such as unit economics and web traffic.
ARR * Multiplier
ARR = Annual Recurring Revenue. This is the primary metric measured for subscription businesses and is also indicative of predictable future revenue for the buyer. The multiplier in this model also relies on financial history, future projections, and addressable market along with customer churn, customer acquisition costs, and other subscription business model metrics.
DCF = Discounted Cash Flow. Similar to EBITDA, this model uses projected future cash flows discounted to the present value to assess value.
Indicators investors are looking for
Expect them to inquire about earnings, operating costs, market potential, and intellectual property.
In addition, to build more value into your business, make the success of the operation less reliant on you. The more autonomous a revenue stream is, the bigger an offer it will fetch you. Investors are looking for a business model that is reliable, reasonably low risk, and easy to operate.
Observe the market
To be prepared for meeting the buyer and presenting your case, you need to understand your own position in the market. What is the market doing right now? Is it trending up or down? And how are you doing in comparison to that? You’ll get a larger payout if you’re excelling in your market. You’ll also get a larger payout if the market is trending up.
One useful way to get a good sense of the market is by viewing the public market. Watch the DJIA and the NASDAQ to stay informed. In addition, pay attention to interest rates and the amount of M&A activity in the private markets.
Value fluctuates, even if your business is marvelously consistent. You’ll get more for a business in a hot market. Keep tabs on the market, and how your company is performing by comparison.
Taking the data and making it useful
Run your data through the models that investors would use. Buyer will look at the last 3 years as a sample size of how your business performs.
They’re going to put the data into certain models, like Discounted Cash Flow. The discount in DCF refers to the idea that a predicted revenue of, say, $100K in year three of a projection has less value than $100K today.
This is because of factors like identifiable risks, industry discounts, the time value of money, and other factors that investors can argue affect the value of their investment.
When doing this yourself, you’re looking for a price range to put your business at — not an exact number.
Another model that investors might use is extrapolating value from the shares of publicly traded companies similar to yours. Of course, the actual sale price of similar companies sold through private transactions will be referenced, too.
Other factors that affect a company’s worth
Valuable intellectual property is an ace in the seller’s hand. For example, if you have a patent on highly valuable software, the investor has to factor that exclusive access into his offer. On the other hand, if you have out-of-date, obsolete software, this is a sore spot that indicates room for improvement.
Subscription based pricing is highly valuable, because its highly predictable revenue. If you can integrate subscription-based pricing into your business model, you’ll have a more appealing offer for investors.
Integrate valuation into your operation
Run calculations often, as much as quarterly or even monthly, if you can. Develop a system for doing so and become proficient with it. Consider ARR and/or EBITDA, DCF, operating costs, market potential, and market trends.
Strive for objective analysis of your company’ worth. Ask for help identifying your blind spots, from anybody who might be a good resource. If you find blind spots that are hard to overcome, bring in outside help to shore up your weak areas and turn them into resounding strengths at the negotiating table. Having good allies will help you make good decisions over time and increase the value of your business.
Knowing where your value is will help you tailor your vision to get that value where you want it to be. The more time you have to work on this, the better off you’ll be. Remember, now is always the best time to start developing your exit strategy.
What appeals to investors?
Have a unique product. A product faces less competition if it’s valuable and hard-to- replicate.
Subscription based pricing (with high retention). Revenue that is extremely predictable.
Exclusive licensing/patents. A competitive advantage that investors control.
Strong relationships with strategic partners. Indicates all the support the business needs are intact. Partnerships also might offer competitive advantages through exclusive agreements. In addition, buyers of your business may end up being a strategic partner.
Data capture. Proof for everything that’s great about your business. Indicates a detailed history of success. Explains how success is attained.
Systems for managing costs. Reassurance that operating will remain efficient once the original owner has exited the business.
Building these qualities into your business model will be well worth the return. Get help in doing so from experienced experts who make it cost-effective for you by accepting equity as payment. To learn about how flexible terms can put you into a winning partnership with FVA, fill out our contact card.
Optimum Value Advisors