Later this month I will be participating in Impact 2016, a meeting of one hundred CEOs, COOs and business owners. The theme of the event is Change. I’ll be co-presenting on the topic of “How to Build a Business a Buyer Would Love.”
It’s a great topic and fits well within the overall theme. We will start with how businesses are valued via the familiar equation: EBITDA x Multiple = Enterprise Value. We’ll then get into increasing EBITDA and increasing the Multiple, both ways to increase Enterprise Value. Most business owner/operators need to increase the Enterprise Value of their business to support their retirement goals. One wants to work on both, of course, but which do you think can be done more quickly? The answer is the Multiple can be increased more quickly than EBITDA.
Keep in mind that the Multiple is the inverse of the risk perceived by potential buyers of your business. Simply stated, as perceived risk to buyers goes down, the multiple goes up. And that means buyers are willing to pay more.
Perceived risk is related to the business continuing to produce the net income or cash flows that it does currently. Or, even better, the perception that net income and cash flows will improve over time. That is attractive to potential buyers and that is how a business owner/operator needs to think. That is, put yourself in the shoes of the buyer. What would make your business more attractive to others?
We’ve established that the Multiple can be changed more quickly than EBITDA. What factors are most important in increasing the Multiple? There are many things and not every potential buyer’s viewpoint is the same. But generally speaking, the single most important thing an owner/operator can do to make their business more attractive and to raise the Multiple is this: Decrease dependence on the owner.
Think about it. If the financial performance of the business is dependent on you, what happens when you leave? The new owner needs to be able to step in and feel confident that the business will continue to run successfully. The less dependence on the owner, especially in the short-term, the more confidence a new owner can have.
Which brings me to what I call “The Three-Week Vacation Test.” Can you take a three-week vacation from your business and know that everything will continue to operate as it should? What if you didn’t call in or check emails? For this to be possible, you would have to have well established systems and competent people in place. Your managers and staff would need to make sales, fulfill sales and services, invoice customers, and make personnel decisions… Well, you get it. They would have to do everything except the long-term strategic planning and decisions. The business would have to operate on a day-to-day basis just as it would if you were there.
When I ask business owner/operators if they could take a three-week vacation, most say they could not. Occasionally one says they can. In any case, it is a great test and if you can’t take a three-week vacation, maybe that’s the goal you should strive for. It would sure make your business more attractive to potential buyers but it would also make your business more fun to continue to own.
In the end this is about building Enterprise Value and having choices.
No comments yet.