Small business owners typically rely on selling their business to fund their retirement.
Sadly, many of these owners will be in for a shock when they discover potential buyers aren’t beating down their doors, or offering them the price they hoped for, come sale time.
Instead, they find themselves stuck with running a business they can neither sell nor walk away from, after so much time and effort has been invested.
If you’re saying to yourself, “That won’t be me”, consider the following questions:
- Is your business saleable now?
- How would the business operate without you?
- If your business were on the market today, would you buy it?
- What would you pay for it?
Preparing for the sale of your business starts well before the “For Sale” sign goes up.
Focusing on the key value drivers of profit, cashflow, growth and risk early on, even in the start-up phase, will ensure you give yourself the best chance of maximising the value of your business.
The value of the business is generally determined by applying a multiple of earnings. The multiple is what is commonly referred to as the price earnings ratio or capitalisation rate.
For most small businesses, this will be between two and four times. Therefore, in most cases higher profitability equates to higher value and businesses should look at ways to increase profitability by improving margins and reducing unnecessary costs and waste.
The future potential profit of the business will also be important to buyers. They want the assurance that not only will the business continue to run smoothly after a change of ownership, but also that profits can be retained at the same or an increased level depending on changes in the market and their ability to improve and grow the business.
Strong cashflow is important to your potential buyers.
Businesses that have a high level of cash available to be returned to the owners or reinvested in growth will generally have a higher multiple applied to its earnings than businesses that have cash tied up in working capital such as debtors and stock.
The two key measures of cash that businesses should know are the level of free cashflow and the cash to cash cycle.
Your accountant should be able to help you with these calculations.
The cash to cash cycle is how long it takes in days from when you spend money to point where the customer pays you.
The quicker the cycle the stronger the cashflow. Reducing debtors and stock holdings are the first things small businesses should look at to improve their cash cycle.
What future potential growth can you demonstrate to an incoming owner? Businesses that are experiencing a plateau or declining sales are less attractive and valuable than ones that will continue growing.
Market developments and industry trends help demonstrate this, but growth also comes from improving how you do things and the capacity you have to produce more or diversify.
Develop a plan for these improvements and start working on them. The gains you start achieving may help attract more funding and additional talent and resources, which in turns assists in executing plans to grow and develop the business.
Risk and value are closely related. Generally, the lower the risk the higher the value.
A business that derives the majority of its revenue from a few key customers would generally have a higher risk profile than a business that has a large number of customers.
Diversifying your customer base where possible means you are not overly reliant on the continued custom of one major customer or customer group.
Most small businesses also rely heavily on a few key people to operate and run the business. Their departure could mean a loss of knowledge and a reduction in the value of the business.
Therefore, it’s important to implement a succession plan and develop the business acumen of individuals in your team to enable them to run the business in your absence.
Not only does this mean you can take holidays away from the business, it demonstrates that the business can be self-sustaining. It also cultivates potential future business owners.
Considering the different potential buyers of your business and making it attractive to any one of them spreads your options.
One such option is a strategic sale to a large business.
Businesses that have a niche product, market, specialist experience or right such as a patent or trademark can be attractive to a large business with the customer base, distribution channels and ability to quickly sell your product or service in higher volumes.
The value of your business under these circumstances can be substantially greater than you can develop on your own.
Focusing on these four drivers of value and incorporating them into your business plan from the start will help to maximise the value of your business.
Working on them will improve the saleability of your business and put you in a position where you have the choice to sell at the right price, when the time is right for you.
Marc Peskett is a partner of MPR Group, a Melbourne based firm that provides business advisory services as well as tax, outsourced accounting, grants support and financial services to fast growing small to medium enterprises.