The real value of a business is the amount for which it can be sold. Business owners interested in selling must ask themselves what would make their business more valuable in the eyes of a prospective buyer. At the same time, maximum value is dependent not just on what some buyer will pay, but on selecting the type of buyer that will pay the most.
Privately owned businesses are typically sold on the basis of a multiple of earnings. Earnings for this purpose are often expressed in a formula called EBITDA (earnings before interest, taxes, depreciation, and amortization). EBITDA is adjusted by adding or subtracting income and expenses that impact the owners of the business but not necessarily prospective buyers, e.g., excessive salaries and perks for the owners. The resulting adjusted number represents the ongoing earnings stream likely to be experienced by a new owner.
The multiple times adjusted EBITDA is the value of the business to the buyer. Inherent in the multiple is the risk level assumed by the buyer. Multiples typically range from 2 to 10 for private companies. The lower the multiple the higher the risk.
Where the company falls in that range depends not only on the risk level, but on the identity or characteristics of the most likely buyer. Generally, there are three types of buyers: strategic, financial, and related. A strategic buyer, typically one in the same or similar industry, may pay a price based on a higher multiple because it can realize certain synergies when combining the two companies. A financial buyer will usually pay based on a lower multiple, and related buyers, e.g., members of the management team, tend to pay based on still lower multiples.
To increase the value of the company, owners will present their earnings as favorably as possible in terms of risk, emphasizing the company’s strengths. But the significance of those strengths depends on the characteristics and perceptions of the most likely buyers.
The first step in the process of increasing value is to identify the most likely buyers and ask what drives value for them and what reduces risk. If you can improve those things, you can be on the path toward maximum value.
What are the elements that affect value? A partial list includes:
- Growth rate
- Geographic diversity
- Quality of the management team
- Research and development capabilities
- Diversity of the customer base
- Strength of the employee group
- Quality of operational systems
- Vendor relationships
Focusing on a list this long may dilute your efforts to make substantial improvements. But if you know what is most important to prospective buyers you will probably be able to focus on a shorter list and have a bigger impact on value.
Finally, value is dependent on the state of the merger and acquisition market at the time of sale. Value can be increased if your personal situation allows you to sell when market conditions are favorable. Your personal situation may affect your timing. If you are emotionally ready to leave the business and pursue other goals at a time when market conditions are right, you may be able to realize maximum value.