What's My Business Worth?
The very first question we get asked is "What do you think I can get for my business?" Unsurprisingly, this is what matters most to sellers. If the potential value is not up to their expectations, they may not even consider selling. Ultimately, a business is worth what someone is willing to pay for it and not what someone else believes it is worth.
Setting valuations in a private market transaction is a difficult task because private markets are not as clear as public markets. Fortunately, as a seller you can list your business for whatever you believe it to be worth and hope someone is willing to pay for it. This endeavor is a balancing act between maximizing your valuation while still making it a good investment for a buyer. There are a handful of items that drive 80% of the value of your business, which are: Earnings, Industry, and Associated Risk.
Earnings will drive the largest part of your valuation. Valuations in the private market tend to fluctuate slowly between 3-5x Seller's Discretionary Earnings (“SDE”). Most buyers in the small to medium sized acquisition space are doing so with a loan or equity capital and, therefore, have much lower valuations then much larger businesses. With all of that being said, all earnings are not created equal.
Earnings in a business with predictability or higher margins will be valued higher. The more recurring revenue that you can implement in your business the closer you are to receiving a valuation 4-5x SDE. If a business can produce recurring revenue and also maintain high margins, it sets the owner up for a very high multiple.
Industry will often dictate how many buyers see your business and how interested they might be. Many buyers care about the industry for two main reasons. The buyer has to have knowledge to operate the business in the industry and it provides either higher or lower risk profiles.
A B2B SaaS platform may be much more intimidating than a lawn care business based on who the buyer is. The more automation you have in your business the more applicable it becomes to a wider set of buyers who may not have the same skillset as you. You should never build a business based on the future buyer's needs, but you do need to be aware of the real valuation placed on these different types of businesses to set realistic expectations for yourself on what you can get.
Risks, of which there are typically many, should be understood from a sellers point of view but be valued from a buyers point of view. Risks can be anything that provide a vulnerability to a new buyer. Risks may be related to financial oversight, industry, market volatility, or revenue concentration. The more risk that you can remove in these areas the better the business will appear. Working with an accountant to ensure you have clean books is a small step to remove a massive amount of risk for a buyer. Industries that have rapid change will hurt the valuation of the business drastically. Most buyers will remove risk by doing an asset vs stock purchase, but that does not remove all risk from the equation. We recommend working for 3-6 months on mitigating buyer-related risk before deciding to list your business.
Taking into account these three items will set you up for success when you do decide to sell your business. However, you should be getting free valuations from multiple sources. We suggest working with a 3rd party that provides significant data to back up their valuation, not just the company that presents you with the highest valuation. Making this distinction will save you time, effort, and money since you will get better visibility from potential buyers when your business is valued appropriately.