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Business ownership can be a great personal asset not unlike real estate or other financial investments. Not only can a quality business yield cash flow during ownership, its value may appreciate over time until it’s ultimately sold or transferred to others.
Business value can be a complicated topic. By their nature, privately-held businesses are less liquid than publicly-traded stocks. Small businesses typically have more risk but can also have a higher financial return when compared to traditional, liquid investments.
So how can a business owner increase the value of their business, specifically if their goal is ultimately a third-party sale?
If you’d like to understand how to add value to your business, it’s worth considering the three hallmarks of a valuable business:
Improve Financial Clarity
Create Processes & Systems
Build Owner Independence
Business owners who address these important hallmarks of a valuable business are very likely to have more options for exit and attract multiple buyers.
Valuable businesses have high earnings as well as high revenue. Put another way, for most small businesses outside of venture capital-backed startups, it’s the bottom line, not the top line on the P&L that matters most to business buyers or investors.
Business buyers seek a consistent, long-term earnings trend that is sustainable and similar to businesses in the same industry. It may sound great that a business keeps half of every dollar that comes through the door. However if the average business in its industry typically keeps only a quarter of its annual revenue, it could be a sign that the owner is overworked instead of properly delegating to a team or skimping on other essential expenses for long-term stability and growth.
When it comes to financial clarity, business owners also need to be able to tell their financial story that is consistent with third-party documentation from the tax returns to the financial statements and all the way back to the business’ bank statements. Being able to do so is the hallmark of solid financial due diligence and will improve the likelihood of a successful sale.
Certain business buyers may appear to be in love with a business concept, brand or industry. However, if the business for sale doesn’t make money, or it doesn’t stand up to the financial due diligence process, the buyer will raise their concerns. Additionally, it’s very likely the business buyer won’t be able to finance the business acquisition through traditional lenders or the Small Business Administration.
Creating financial clarity involves recording income and expenses in a detailed format, appropriately recording expenses and investments appropriately on the P&L and Balance Sheet, respectively, and being able to answer questions about common fees like tax payroll taxes and merchant fees. Recording expenses in modern financial reporting software is a must in today’s sophisticated business acquisition climate. Whether it’s QuickBooks, FreshBooks, Wave Financial or similar, using software is preferred. Handwritten or even Excel-based bookkeeping will likely raise a caution flag by business buyers.
All of this recording and reporting is a great segue to our second hallmark of a valuable business; creating processes and systems for the business operations and administration.
Processes and Systems
Valuable businesses are attractive to business buyers because they have processes and systems for operations and administration. Each process and system ties to all customers, products, vendors, etc. to enable employees, managers, and leaders to report accurately, communicate effectively and ultimately make smart decisions.
For example, when a new customer initiates a purchase, a standard operating procedure should be in place that will allow the order data to flow through the entire business operation and administration. While the purchase order may start in the sales department, it will travel through the warehouse, inventory, shipping, accounts receivable, and ultimately end when the payment of the invoice is received.
Intangible assets such as a good CRM (Customer Relationship Management), an effective lead-generation website, and a great marketing program are very attractive to buyers. Similarly, well-documented HR policies and employee handbooks are vitally important too. Savvy business buyers will recognize a business that is well organized and equipped to serve a growing business.
This type of intangible “goodwill” is what business buyers want to acquire instead of trying to build it themselves. And it’s a value they are willing to pay for!
So let’s bring this all together with our third hallmark of a valuable business, lack of owner dependency.
If a business has invested in it’s people and processes and systems effectively, there’s a decent chance that the owner is no longer the face of the business. The business owner can probably take a vacation if he or she has a team to manage the business and there’s a plan for how to handle issues that typically arise. If so, this is exactly the type of business that business buyers are most interested in acquiring.
While a small business is inherently owner-dependent in most cases, certain owners are able to succeed in a semi-absentee state for long periods of time. While it’s hard to measure owner dependency, businesses that are effectively structured to earn a profit after supporting all of the systems and people needed to keep owner independence are very attractive to buyers. In fact, if we could all own absentee businesses, there would literally be no limit to how many businesses we could own and how much money we could make.
Add Value to Business for Your Best Outcome
In conclusion, it’s not easy to build a business that has maximized it’s value, but those business
owners who have enjoyed the opportunity to sell their businesses to multiple buyers often enjoy more profit and more time and freedom from their businesses.
Even if a business owner does not plan to sell, paying attention to these three hallmarks of a valuable business will improve the owner’s income as well as quality of life.