Selling your business is a significant milestone. After years of hard work and dedication, it’s time to close this chapter and move on to the next. But how do you price a business for sale? And what factors can you control to influence the final sale value?
Revenue and profitability are obvious factors, but there are several other things to consider when aiming to maximize the final sale value of your company.
In this article, we’ll cover the following:
- Appraisal methods for valuing a small business
And more importantly…
- How to maximize your profitable exit
How Much Do Businesses Sell for?
It’s impossible to say with any specificity without more information.
However, Bizbuysell, an organization that matches and facilitates small business buyers and sellers, reported that in Q1 2023 a sample of businesses with median revenues of $700,000 sold for an average of $350,000 with an average asking price of $375,000.
Appraisal Methods for Valuing a Small Business
There are a variety of ways to establish the value of a small business. It’s worthwhile to keep them all in mind so that when it comes time to sell, you can draw attention to the appraisal that shines the best possible light for you.
Valuation Based on Revenue
A simple revenue multiple is often used. They vary from industry to industry, but the basic logic is that the more scalable a business is, the higher the multiplier.
Here are some industry-specific benchmarks.
Software as a Service
0.5 – 2.5x
0.5 – 2.5x
0.2 – 1.5x
0.2 – 1.5x
For a more comprehensive list of revenue multiples by industry, see here.
Owner’s Discretionary Earnings
Profitability is of course the most important factor determining the value of a business. But when you’re selling, the best way to represent profit is different than how you might on a tax return.
Let’s look at an example:
A company with $1,000,000 in revenue reports $50,000 in net profit to the IRS. But, the owner draws a $100,000 salary and another $25,000 in benefits between 401k matching, health insurance contributions, and travel expenses.
That means that the net profit of the company may have been $50,000, but the total benefits available to a buyer of the business are actually $175,000, quite a bit higher than what you would have reported to the IRS.
Asset Approach Valuation
What’s the fair market value of your present assets, less liabilities?
This method doesn’t take into account future revenues but is useful for setting a lower-bound estimate of a company’s value. In the worst possible scenario, the business will be worth at least this much in liquidation value.
Comparable Market Analysis
Comparing similar businesses that have been sold or are on the market is a great way to benchmark what yours might be worth. Just like in real estate, it’s also a great way to identify differentiating factors that can raise the final sale price. Did a particular company overperform the average? Why?
Discounted Cash Flow
The discounted cash flow method incorporates the time value of money into the valuation process.
By combining a cash flow analysis with growth projections and an appropriate discount rate, potential buyers receive an estimate of the minimum rate of return a purchase would need to yield in order to justify the investment over equally or less risky options.
This method is sensitive to changes in growth projections as well as interest rates and inflation, so it’s less concrete than the approaches mentioned above.
How to Maximize Your Profitable Exit?
Investors and their creditors will want to know two things as they’re evaluating your business: how have you performed in the past and can the company be relied on to perform in the future?
Aside from the obvious and improving your profitability, here’s what you can do to position yourself for the best possible sale.
Leave Behind a Strong Management Team
A business that is dependent on the owner for day-to-day operations is risky. Will the buyer be able to fill your shoes? Do they even want to fill your shoes? After all, they’re buying a business, not a job.
Your team can provide continuity through the transition, provide operational expertise once you’re gone, and save them the headache of searching for employees themselves. Plus, if they already have a track record of successfully leading business growth, this can lend credence to the growth projections that have inevitably been part of the negotiations.
Keep Impeccable Financial Records
Good record-keeping demonstrates transparency and will instill confidence in potential buyers. Not only that, but this is your opportunity to spell out in detail exactly how much potential your business has.
In an ideal world, you’ll have the following available when it comes time to sell.
- Three years worth of monthly financial statements
- Three years of tax returns
- A list, and value, of tangible assets (property, equipment, inventory)
- A summary of accounts receivable and accounts payable
- A list of intangible assets (patents, trademarks, vendor relationships)
Lastly, while you’re still the owner, don’t run personal expenses through the business and write them off as business expenses. When the bank considers underwriting this deal, they’re going to consider those as actual business expenses and it’s going to weigh down the amount they could ultimately lend.
Document Standard Operating Procedures
When SOPs are well-documented, it indicates to the prospective owner that the business has established systems. Outlining the step-by-step processes for your operation, before the sale, provides insight to prospective buyers about how difficult it will be to replicate and build on your success.
The more detailed your SOPs, the better.
Diversify Your Customer Base
Just like with stock portfolios, a well-diversified customer base minimizes the risk of relying on a small number of clients.
Loyal customers with long-term contracts can lend a sense of stability to your company, but buyers also want businesses with broad customer portfolios across industries, geographies, and client types.
Avoid Legal Entanglements
Pending lawsuits, regulatory violations, or compliance issues can pose both financial and reputational risks. Investors interested in companies facing these issues will be looking for a significant discount.
Plan for Taxes Intentionally
This is something most people don’t think about until it happens, but selling your business is going to create a windfall. Careful tax planning can minimize your liability while maximizing the after-tax proceeds from the sale. Deal structure, tax deferral strategies, and sale timing can all have impacts and should be planned for accordingly.
Look for Creative Ways to Structure the Deal
Perhaps your buyer is genuinely interested but needs some leniency on financing. You could accept structured payments instead of cash upfront in exchange for a bigger back-end payout.
Maybe they’re concerned that growth estimates are too ambitious. Including an earn-out agreement where a portion of the purchase price is contingent on the future performance of the business is a solution. They protect their downside risk while you have the leverage to ask for a higher price in exchange for sharing the risk.
Another creative approach is an equity exchange. Instead of receiving purely cash for the business, you could also accept some equity in the acquiring company as part of the deal.
Get a Professional Business Valuation
An appraisal by an experienced professional provides an unbiased assessment of the business’s worth and can add to the credibility of your asking price. Not only that, but they will be able to identify key weaknesses in your business that, if addressed, would improve their assessment.
Cultivate Intangible Competitive Advantages
None of these fit neatly onto a balance sheet, but they have considerable value nonetheless.
- Do you have unique relationships with suppliers or distributors your competitors don’t have?
- Do your socials have more followers than your competitors?
- Do you have uniquely valuable customer data?
- Do you have any proprietary technology or intellectual property?
- Do you have an exceptionally well-known brand?
Wait For the Right Time
Did you know that, according to Steven Levitt of Freakonomics, realtors sell their own homes for ~3% more than their clients? That’s because they’re just a little more patient than the rest of us.
Market conditions, interest rates, and general industry performance are outside of our control, but waiting for favorable conditions or simply waiting for the right buyer can go a long way toward boosting sale value.
You could time the sale irrespective of market conditions, too. If you’ve had a breakthrough year and grown considerably in recent quarters, you’re in a strong negotiating position.
Selling a business is complex. This guide provided a broad strokes overview of common valuation techniques as well as ways owners can position themselves for the best outcome possible. But no two deals are alike.
Trivium Point Advisory guides business owners considering selling their businesses to prepare for minimally painful and maximally profitable exits.
When it’s time, let’s schedule a conversation.