How often do you wonder what your business is worth?
Many business owners work their whole lives without planning how much wealth they will need to accumulate for them to retire gracefully. It’s self-evident that one major asset in your future retirement plan lies in how your business is doing. But sadly, there is often a huge expectation gap between what a business owner thinks their business is worth, and what someone will actually pay for it.
Most businesses are valued based on a multiple of earnings before tax, interest and depreciation/amortisation – known as EBITDA (in layman’s terms, this is your profit with some minor adjustments).
Larger (and especially publicly listed) businesses sell for higher multiples than smaller businesses. As a rule of thumb, a small business might sell for roughly half the multiple of a quoted business.
Below are some of the key drivers of privately held business valuation:
If you are looking to sell your business, then this is the place to start. Ideally, you’ll want to give yourself three to five years to significantly improve the financial performance of your business.
If someone acquired your business, would they have a clear path to growing your existing revenue? Do you have loyal customers who are keen to buy more? Are there opportunities to introduce new products and services? And generally, where is your industry life cycle?
Are you cash flow positive or cash flow negative? How quickly do your customers pay you, relative to the cash you need to send out to suppliers and to hold inventory?
Dependency on the owner
If you walked tomorrow, what would happen to the business? Where do the customer relationships lie – with you, or the business? How strong are your systems and processes? Could they be picked up by a new owner so that the business could thrive without you in the picture?
This last consideration is critical. Ask yourself these three questions about your business systems:
1. Do you have clearly defined and documented systems in your business?
2. Do all team members know about them?
3. Does everyone use them consistently?
A business with a fully documented systems manual that is consistently used by all team members is usually considered to be more valuable than one where all of the knowledge resides in the head of the owner. The more the continued success of the business is dependent on the owner, the less someone will want to pay for the business.
Interestingly, this can be a contentious issue in family businesses and needs to be taken into consideration in succession planning. If Dad has run the business for 30 years and holds all of the customer relationships, the NextGen family member might (and should) contest the value placed on the business by Dad. There is significant risk that customers might not be retained as the business passes to the next generation, as well as operational issues that could arise as a result of a lack of systems.
To ensure you can retire gracefully when the time comes, take some action now by reviewing your current situation and then planning for the future. You’ll be glad you did.
Colin Dunn is a director of Proactive Accountants Network Pty Ltd.