The 2 key things that can affect your business value
How can you make your business worth a larger amount when you want to sell it?
Before we answer this question, remember: your business will only be worth what someone else is willing to pay for it. How can you attract a buyer and get them to pay the price you want?
A basic business value formula
Most small and medium sized businesses are valued using a business valuation method known as the “Capitalisation of Earnings” method:
Business Value = ‘future maintainable earnings’ x Multiple
Future maintainable earnings:
This is usually calculated as ‘normalised EBIT’ – EBIT being earnings before interest and tax, and ‘normalised’ meaning it is adjusted for any abnormal one-off items, as well factoring in a commercial salary for the business owner(s).
‘Normalised EBIT’ would usually be determined as an average of prior year and forecasted EBIT.
Working out the appropriate multiple is often the most difficult thing to agree on when valuing a business. For most small and medium sized businesses, the multiple is usually between 1 and 5.
For example: A business with future maintainable earnings of $200,000 is assessed to have a multiple for sale purposes of 3.
Business value = $200,000 x 3 = $600,000.
How to increase business value
Using the above valuation technique, there are 2 ways to increase your business value.
- Increase EBIT; and/or
- Increase the multiple
Increasing EBIT is all about your business making higher profits by increasing revenue and/ or decreasing expenses.
Increasing the multiple involves making your business less “risky” to the buyer.
The buyer is buying a cashflow from your business into the future. If you can clearly demonstrate to the buyer that this cashflow is strong, is not expected to stop, and is expected to increase over time with business growth – then the multiple you can ask for will be higher.
Here are a few things that will lead to less risk for your business, and therefore should lead to a higher multiple when you sell your business:
- Proper systems so the business can work without the business owner having to be there.
- Prove to the buyer the future growth of the business
- A diverse, expansive customer base (so the business doesn’t just rely on a few key customers)
- Contracts with key suppliers that will continue after the business is sold.
This information is just a general starting point to help you understand how to make your business worth more. Remember, it doesn’t happen overnight. You ideally want a 3 to 5 year plan to properly do everything needed to have your business sale ready.