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The short answer is a cheeky one because all the formulas and rules of thumb are estimates at best. Just like selling a house or buying a car, the real number is entirely dependent on what an acquirer is willing to pay for it. That’s where the math gets tricky, because you may find two different acquirers looking at the same business and coming up with different valuations.
What a buyer is willing to pay for your business is going to depend in large part on what they want to do with it once the acquisition is complete. Most commonly, there are three types of people or groups that may be interested in acquiring your business:
For small businesses, the hunt for a buyer often leads to an individual investor. These are people that are essentially buying themselves a job as they are looking to get into a business of their own. Frequently, individual investors will take on a lot of debt to buy your company. This can be done through a bank, like a Small Business Administration (SBA) loan.
Oftentimes, if you’re selling to an individual investor, you’ll wind up financing some or a lot of the purchase price yourself, with the new owner paying off that debt using the cash flow from the business over time.
The next type of buyer you may encounter is a financial buyer. These are typically institutional investors, like a private equity group, that are buying your future stream of profit, and that’s how they decide what your business is worth.
Since your business value to a financial buyer is based on your future cash flow, the way to increase what your business is worth is to not only increase your cash flow but to improve its reliability. If your revenue is on a set schedule, such as through a subscription, then it will look more reliable to an interested financial buyer than if it’s sporadic through milestone and deliverable payments.
A strategic buyer is the final type of buyer. They usually want to incorporate your operations into theirs to drive new growth, and they develop an offer by estimating what the value of your company will be once it’s in their hands. Similar to a collector buying a piece of fine art, what your company is worth to a strategic buyer is highly subjective.
Despite that subjectivity, because a strategic buyer is more interested in a market segment or a growth driver that your company brings to the table and how it will integrate with their business, they may be less concerned about your future stream of profit than a financial buyer. So even if, for example, your revenue may not all be subscription-based, your business model could still be highly valuable to them.
Your likelihood of finding a buyer depends on a lot of different factors. The smallest businesses, those with less than $1 million in annual revenue, make up the largest percentage of small and medium businesses, but they often have less to offer a buyer, aside from an individual investor who wants to join the entrepreneurial community.
On the other hand, the largest of small and medium businesses, those with $10–50 million in annual revenue, may feel like more of a sure thing to a buyer, but they also demand higher selling prices, which limits the number of potential acquirers that can hit those numbers.
Many business owners that are looking to sell start to think about it somewhere between $1 million and $10 million in annual revenue. They have a well-established business with proven growth, but they also aren’t so big that it will make it hard for a strategic or financial buyer to put together the cash for an offer. In fact, businesses in this revenue range made up more than 50% of the SMB M&A transactions in the last 12 months.
If you’re thinking about getting your business ready to sell, you probably already have a number in mind. This could be the amount of money you need to pay back investors, fund your next venture, or set you up so you never have to work again.
So how do you figure out if your company’s value is going to hit your number?
While the bottom line is still that your business is only worth what someone will pay for it if you’re just looking for an estimate to make sure you can get close to your magic number, there are a few resources available to you:
For many industries, there will be an industry association where you can get ballpark numbers on what your company might be worth, usually as a multiple of revenue, pre-tax profit, or EBITDA. While these numbers may not always be publicly available, they can be provided to members or found through online discussion forums or at in-person events.
Alternatively, if you aren’t able to connect with an industry association, you can speak to an M&A professional. Many will specialize in M&A in a particular industry or geographic location. So if you want to know what the typical multiple for digital marketing agencies or a family diner in Spokane, Washington, might be, touching base with a well-reputed M&A professional is a good way to nail down some ballpark figures.
Similar to an online mortgage calculator, the Value Builder System™ valuation algorithm can help give you a sense of what your business is worth, particularly as it relates to your performance among the Eight Key Drivers of Company Value.
The algorithm generates estimates of company value based on industry-standard data sources of over 55,000 market transactions along with rules of thumb for hundreds of North American Industry Classification System (NAICS) codes to determine the average market price.
The advantage to using the algorithm is that while it doesn’t give a guaranteed sale price any more than industry associations or M&A professionals will, it allows you to see how changes to your operations through the eight key drivers will impact your sale price so you can prioritize the changes you want to make before you take your company to market.
We get this question all the time, and it’s often motivated by the disappointing reality for many business owners that after a lifetime of hard work, their company’s value is less than they had hoped. The news can be devastating if you’ve hinged your retirement plans on a healthy payday.
If you’re in this situation, you’re not alone. As Bill Dunnington of Dunnington Consulting says, “Virtually everybody overestimates the value of their company. The first step is to understand by how much and why in an actionable way.”
Value is about how much your business will make for a buyer once it’s in their hands. Put in the opposite perspective, if your business’s operations are completely dependent on your active participation, then it has no value for someone else. In fact, businesses, where revenue is entirely dependent on the owner as the rainmaker, are 47% less likely to even get an acquisition offer at all than those that aren’t.
If you’re the only one who understands the bookkeeping system, the only one customers want to talk to, and the only one who can close sales, then the business has no value to a buyer.
If you’re looking to increase the value of a business that depends on you to run, oftentimes it’s going to require a philosophical shift in perspective. It may be that you’ve spent your career focusing on your profit and loss statement, keeping a close watch on revenue and EBITDA. When you’re trying to keep the money coming in, it’s easy to get stuck in what we call “The Owner’s Trap.”
But just like sending your kids off to college, when it’s time to send your business off with someone else, you need to know it’s going to stand on its own. So while an impressive P&L statement can feel like a big draw, if the numbers will dry up when you walk out the door, then you’re no further ahead than the parent of a college student who can’t do their own laundry.
If your business depends on you to keep your books in the black, then you may face disappointment when it’s time to sell. Either you won’t get the payday you’re hoping for or you’ll get stuck in a slow transition as the new owner tries to learn everything that currently lives inside your head. Alexander Rattray, Director at Excolo33, says, “I find the biggest misconception is that owners think they can choose to sell one day and it will be done in a couple of months with them completely gone.” If this is your dream, you may be in for a rude awakening. A Certified Value Builder™ can help you build a plan to get you out of the Owner’s Trap. To get started, complete the Value Builder Questionnaire to better understand the drivers that are holding you back from a successful business exit.