Confessions of an Entrepreneur: Nine Things that Make Your Business More Valuable
October 6, 2020 | By Mark Zweig
Not every small business is an entrepreneurial venture — some are just small businesses.
Not that there is any shame in owning a small business! Some allow their owners to live the life they want to live as well as make an excellent income. But they don’t have a lot of value as a “going concern” that one can cash in on at the end, other than the physical assets they may build up over time.
An entrepreneurial venture, on the other hand, builds significant value for the owner(s) that they can harvest upon their exit from the business. Its value is much less tied to its balance sheet than it is to a buyer’s assessment of its future income-generating potential.
That multiplier on “owners’ equity” is therefore one of, if not the primary distinguishing characteristic of the entrepreneurial business vs something that is a typical small business.
Over the years, I have started, owned, operated, bought, and sold both small businesses and entrepreneurial businesses of my own, as well as been involved to one degree or another in hundreds of other transactions involving privately-held companies as an outside director, minority shareholder, or consultant in some capacity.
What the owners are able to harvest at their exit from their business varies wildly. Some get little to no payback for their years of toil and struggle. And some do incredibly well and become wealthy beyond their wildest dreams.
Let’s take a look at some of the contributors to value for a business for those of you who’d be interested in having the proverbial “pot of gold” at the end of your rainbow. To qualify my points below, let me say most of what I am saying applies to an external sale. That is typically where the value is greatest.
Going public is rarely an option for the vast majority of private businesses, and internal sale or ESOP options typically won’t bring the highest value for exiting owners. That said, all of my points below should increase value in ANY exit scenario.
So here are some of the top value drivers:
- Good brand name.
- Unique products/services not available anywhere else.
- High revenue growth rate.
- High profitability.
- Good cash flow.
- High market share.
- Strong second tier management.
- Good employees.
- Client/customer database.
A strong brand brings in business. It also usually allows the business to charge more than those without such a recognized and grown brand. And yes, you can be a “brand” that is only well known to a narrowly-defined target market. The whole world doesn’t have to recognize your name—only those in your target market. This brand usually results from consistent and higher than competition marketing and advertising expenditures over an extended period of time. The brand can add significantly to your value as a business.
I can say this until I am blue in the face. Don’t sell the same stuff people can get from any number of other sources. It puts you in a race to the bottom in terms of pricing which will kill your margins which will make it hard to afford good people and afford to spend what you need on marketing and advertising. Unique offerings (and that doesn’t necessarily mean patented products you own the patents to) are critical to building value in the business.
This may be the single most important thing you can do to increase the value of your business. We have all seen examples of the crazy valuations of rapidly growing publicly traded companies. The same thing applies to privately-held companies. I recently worked with a business that was valued by a private equity firm at three times revenue in an industry that more typically has valuations of 70-80% of revenue because it had tripled in size over the last five years. Enterprise value is based on projections of future income, and high revenue growth rate is the best indicator of the future. I have a lot of small business owners try to tell me that profitability is more important and they cite multiples of EBIT as the driving number for value. But the key there is “projected EBIT.” Believe me, I have recast the numbers of many privately-held firms in the midst of a sale, and high revenue growth rate will make that job a lot easier!
Of course, being highly profitable is going to increase value—as anyone would expect. Most industries do have “typical” valuation multiples, ranging from three to eight times EBIT depending on what that industry is and its risk profile. The problem with maximizing profitability over growth from a value standpoint is that any experienced external buyer will assume that the high profitability cannot be sustained post-sale, and there’s a lot of evidence to support that. Conversely, a seller will never pay the full penalty for lower-than average profitability because buyers usually assume they will manage the business more effectively than a low-profit seller, AND “strategic” buyers will get post-transaction overhead cost reductions in many cases from consolidation savings when adding the selling business to their own businesses.
Good cash flow means that any new owners may not have to put more money into the business post-seller-exit, and may even generate cash they can use elsewhere. That is going to increase their valuation for the business. Conversely, weak cash flow that will require capital injections of one sort or another will negatively impact value.
Having a high market share is an indication that the market likes what this business is providing. That’s a good sign for what the future opportunities will be and increases the value of the business.
We were talking about this in my New Venture Development class last week, and some of my students were surprised that was something that would increase the business’s value. It does because the buyers know the reason most sellers sell is they want to truly exit the business. Who will be left behind to run the business is critical to the risk they are taking on by buying it.
Same logic as point #7 above. A strong team of people increases the value of the business. Happy employees with low staff turnover rate, and smooth-running operations increases the value of the enterprise.
This client or customer database is one of the hidden assets a buyer may get when they buy a business and it can be very valuable. For example, when we sold Zweig White in 2004 to a private equity firm that owned a magazine group and tradeshow company that served the same client base, our client and customer database of more than 200,000 people was extremely important to them and was helpful to our getting a higher price for the business.
I’m sure I could keep going here as there are additional value drivers, but we can save some of those for a future post. The bottom line, however, is that an owner who is conscious of and working on the drivers of value for their business will do better at exit than those who aren’t!