Do you know what your business is worth? If you don’t have immediate plans to sell, it may not seem important. You don’t need to spend the money on a certified appraisal to understand the range of values that your business is in. Knowing what your business is worth and what factors would drive higher value helps you make good decisions going forward.
There is a lot of complexity to the various methods of business valuation. For our purposes here, we’ll keep it simple. You want to maximize what a buyer would pay for the business.
The multiple of earnings method is a simple, intuitive way for owners to understand the range that a buyer would pay for a business in their industry. Business categories have ranges of multiples of earnings that they sell for.
As an example, the range may be 3.3 to 7.2 in a particular business type. If the business’ earnings are $1,000,000, the value range for the business would be between $3,300,000 and $7,200,000. Where do you fall in that range? It depends mostly on the intangibles of your business. What are the intangibles?
It may make sense to define the tangibles first. These are the black and white numbers. Having predictable cash flow and a clean balance sheet. This is the nuts and bolts of running a business and you probably do it well if you’ve been in business for any period of time. If the business isn’t running well, the numbers won’t lie and the intangibles won’t matter very much. The tangibles are represented in the earnings part of the multiple of earnings equation.
The intangibles are represented by the multiple itself. Using the example above of a low end of a range being $3,300,000 and a world class company with the same amount of sales is $7,200,000. This is a 118% increase in value at the same amount of earnings! How does that happen and what are these intangibles?
There are 4 broad categories : human capital, structural capital, customer capital, and social capital. Much more value can be driven by focusing on these areas. The impact is obvious when you understand the math. These things also increase the quality of the business so improving them often means more earnings. Business strategy can be structured to systematically improve these areas.
Human Capital. Are the right people in the right roles? No matter how good your team, there are always ways to get better. Develop a management team that can run the business without you. Improve training, professionalize HR.
Structural Capital.Document your processes. Integrate computer and data processing systems. Document the processes, technology, infrastructure, and services that make your business special. Many businesses store these processes in the minds of the owner and key employees.
Customer Capital.Are contracts in place with your customers? Do you have concentration issues? ie >25% of revenue from one customer. Is your relationship with customers entangled enough in their processes that it would be difficult to replace what you do for them?
Social Capital.How is the company is perceived by its customers, employees, and the public? Create a clear, consistent, and compelling message. It can be a swagger or a way of doing things that makes your company special.
If done with intention, these categories can be systematically improved over time. The beauty is that it is a process. Most business owners cannot take these types of projects on without help because they are too busy running the business. Build a team to help you. There are professionals who can collaborate across professional disciplines to help you get to the high end of your range. It isn’t easy but understanding how multiples work can impact your wealth more than solely focusing on incremental sales increases.