There are a lot of factors that drive the value of a business. While a lot of small business owners know they want to sell their business one day they usually spend a lot of time in the day-to-day operations of trying to grow revenue and generate a profit. While this important to both an owner’s current financial situation and future business value there is much more to it. The value of a business can be boiled down to a simple formula (how much cash flow the business generates, times, a multiple of that cash flow).
In order to maximize the value of your business you need to focus on both sides of the equation. The typical business owner knows how to fix the former and spends little time thinking about the latter part of the equation. The reality is, increasing the multiple is the fastest way to create value.
Let’s look at 2 examples. Each company generates $500,000 of cash flow to the owner every year. However, 1 business is valued at a 2 multiple ($500,000 x 2 = $1,000,000) and the other business is valued at a 3.5 multiple ($500,000 x 3.5 = $1,750,000). Looking at this another way you would have to grow your cash flow by 75% ($875,000 x 2 = $1,750,000) to get the same value as a 3.5 multiple business if your multiple stays at 2. Any business owner knows how difficult it is to grow their cash flow by 75%. The question then becomes how do you grow the multiple on your business.
First, let’s take a step back and think about what goes into the multiple. The multiple at its core is simply what someone is willing to pay for your business. There are many factors that go into this such as owner involvement, profitability, concentration of clients, employee retention, sales and marketing practices, size of market, variability of earnings, etc. The bottom line is the more turnkey your business, the higher your multiple. Think of it like this, would you spend more for a house that is move-in ready or a house that requires a lot of work, not just cosmetic fixes but structural issues?
Each factor plays an important role in increasing your multiple and accelerating the value of your business. However, in my experience the biggest mistake I see with business owners and also the quickest way to increase value while also increasing the probability that your business sale closes when you go to sell is having clean books and records.
The number of small businesses that do not have well-kept books and records along with processes to review those records is higher than you would expect. In fact, most owners that think they have this covered, usually have some deficiencies that they did not even realize. This seems like such a simple step, but there are so many small businesses that keep information in their heads because “they know” the business. Additionally, there are so many businesses that I come across where they do not even close their records on a monthly basis. They may use accounting software such as QuickBooks, but things are not reconciled. When it comes time to sell, this is the first thing a buyer and the buyers’ lender will look at. If there are issues with the books, lenders may back away and buyers may look to lower their price or walk away all together.
The fascinating thing about having clean books and records is that it does not just affect the multiple. Think about the informed decisions you as a business owner can make when you can identify strengths and weaknesses in your business. By having a process to consistently review your books you will be able to spot problems early and adjust your business to react. Also, you will be able to spot strengths in the business where you can focus your energy to help make the business that much better.
This seems like such an easy step and almost every business owner already has something in place to keep track of the business. It is the consistency and process for review that separates the lower multiple business from the higher multiple business. I urge any business owner to sit down for 10 minutes and ask themselves honestly if they can improve their record keeping and how much effort it would take to get it right. You will be surprised by how much benefit a business can derive from this sim