How to build the value of your business
SME owners have a well-deserved reputation for being passionate and hardworking as they seek to grow their businesses.
What many of them don’t know, though, is how to measure or increase business value. That’s simply because many of them are too busy working in the business, not on the business. Those that do think about value markers tend to do so a year to six months before a potential business sale, which is too late.
So, let’s consider the value of a business first. This is calculated based on its ‘earnings’, or profit, times a capitalisation number known as a ‘multiple’. An adjustment is then made for the ‘net assets’ on the balance sheet. There are plenty of strategies that can be called upon to improve the earnings and balance sheet components of the calculation, but the key here is the multiple because it effectively reflects how risky a potential buyer sees your business, and thus what return on their investment they expect.
To put some numbers around that calculation, if an investor buys the business at a multiple of four, they are effectively saying they expect a return on investment of 25 per cent. They are paying four times your profit with a view to recouping that investment within four years. Fortunately, there are a host of key strategies that can be rolled out to ‘de-risk’ your business and boost that multiple.
5 levers to pull
Most investors seeking to acquire a business are after a risk-free asset. That is, they want to be confident that the business will continue to run really well after they take over; that it will generate healthy profits; and that it has a strong growth runway where there is evidence of future growth prospects. What else? No hidden legal issues. No product or service bans. No surprises.
To improve a business’s value, here are five common levers that can be pulled.
Increase revenue, or maintain profits, through organic growth
Revenue streams should ideally be diversified to ensure the business is not subject to market fluctuations. Investors tend to like an annuitised revenue model – that is, one that delivers regular, recurring income.
The logical ways to grow revenue through organic growth include expanding services and products to existing clients; onboarding new clients through strategic marketing activity; and repricing products and services to new and existing clients when you can demonstrate value uplift. At the same time, you should be driving down costs without hurting the business’s operating model.
Maintain a strong balance sheet
This entails making sure the business has sufficient working capital and that it hasn’t leaned too heavily on debt to grow. A potential buyer will want signs of sustainable business value, not an operation that is too dependent on money from the bank. At the same time, debt can be a key component of future growth and it helps to demonstrate strong relationships with financiers.
Try not to lock up working capital; in other words, it shouldn’t all be tied up in accounts such as debtors, stock, or unbilled time servicing customers. Cash should also be managed tightly, ensuring reserves are sufficient for future needs.
Ensure you have scalable infrastructure
Write down procedures for all your core business functions and make sure staff follow them. This one-way, same-way approach creates efficiencies, leads to more consistent client engagement, and helps create a business operation that investors are more likely to buy.
Insist on a disciplined governance program
This is a factor that smaller mum-and-dad businesses, in particular, can overlook. Make sure you get impartial guidance from industry sources who can advise on best practice and proper strategy execution. This process can also address aspects of the business that may need fixing, and the chief barriers to success and how to overcome them. Such a strategic focus is imperative to ensure the business can continue to grow its revenue and value.
Set up a structured human capital framework
Your staff are your most valuable asset, so having the right recruitment and retention processes is a proven way to increase the value of the business. Remuneration packages and bonus systems should be well managed, and staff wellbeing programs should be on the radar.
Get these factors right and you’ll be leaps and bounds ahead of the opposition. Just as importantly, you’ll find that the value of your business will soar, too.