When we talk to business owners who are ready to sell their business, we spend a lot of time reframing their view. There’s a big difference between being an entrepreneur who’s built a business, and the same business owner who’s decided to sell their company. We talk about looking at their business from the buyer’s lens and what’s important to them. About restructuring their business into a “built to sell” company and uncovering their hidden value that attracts buyers who will pay you what your business is worth.
This is an important step for an owner. Buyers are looking at a specific set of drivers that indicate the value of the businesses they’re evaluating. A common set of criteria if you will that separates the average companies from the great ones. Over the years, we’ve done a lot of research and learned through our own exit planning and brokerage teams what’s nice to have versus an almost universal requirement of most buyers. Here’s what we’ve discovered:
Your financial performance is critical and can be a deal-breaker right out of the gate if you don’t meet the buyer’s investment criteria. It’s why you need to make sure your financial and accounting records are clean and accurate, and it’s your company’s best representation of your performance over time. Errors and irregularities are often deal killers right from the start. Buyers are naturally gun shy when it comes to small and lower-middle market company’s books, since they don’t have the professional CFO’s and accounting resources on staff to produce accrual-based books according to Generally Accepted Accounting Principles.
We all like satisfied customers, and buyers are no different. But they look at this a little differently. Strategic buyers hunt for companies that have a high potential for growth because they know they can scale them. The key is measuring your customer’s satisfaction with your business in a unique way that is recognized to showcase companies with a high potential for growth.
To do this, we like to get our customer’s net promoter score by capturing their customer’s response to this question, “On a scale of 0 to 10, how likely are you to repurchase from our company and refer our company to your friends and colleagues?”
- People who give you a 9 or 10 rating are your promoters
- People who give you a 7 or 8 are your passives
- People who give you a 6 or below or your detractors.
You take your percentage of promoters and subtract your detractor’s percentage to get your score. Let’s say you get 100 respondents from your confidential survey, and 50 give you a 9 or 10, and 18 give you a 6 or below. You’d have a net promoter score of 32 (50 minus 18). Since the average business only scores a 15, and world-class brands score a 50+, that’s pretty good and definitely better than average.
Buyers are looking for companies that have the potential to scale and grow, and this is a combination of having the right product and service mix in the right markets. Buyers understand that to scale a business, they’ll need working capital to grow it, so positive cash flow is vital to a quick growth curve. More on that later. They’ll also look at the markets the seller currently serves and how they can bring a seller’s business into their business development and marketing engine to accelerate the growth curve and provide cross-selling and up-sell opportunities.
Recurring Revenue Potential
Buyers have been willing to pay two to three times revenue for companies that bring in a large portion of their revenue through subscription models, which is significant. When you compare that to most valuations multiplying your net profits by a multiple to arrive at your company’s worth (I’m oversimplifying, but you get the idea), you can see the significant upside potential. We’ve written a blog that goes over the nine subscription models that bring in automatic customers – it’s worth a read.
Uniqueness and Competitive Differentiation
We’ve all played Monopoly or at some point heard of it. It’s a simple board game where you build houses and convert them to hotels, with the goal of making all or most of the money from your fellow game players. You want to corner the market and create a monopoly, hence the name. Buyers are hunting for businesses with strong brands that are unique in the marketplace and provide a competitive advantage.
There’s many ways to arbitrage, and oftentimes it’s how the companies market their product and services, the outrageous customer service they provide, or something new and different that gives the business a headstart on their competition. Companies that are unique and different usually command higher prices for their products and services, which in turn generate higher gross margins and downstream net profits, which is valuable to buyers. And they want to understand your unique value proposition that resonates with your customers that separates you and makes your customers raving fans who want to not only buy more of what you sell, but they want to tell their friends and colleagues to purchase, too. (see how these intertwine?)
We’ve spent a lot of time on owner-dependency and its impact on your company’s value. Businesses that are dependent on their owners, even synonymous with them, are essentially worthless to buyers. Why would a buyer buy your company when it takes you to run it? Buyers know that in order for an owner-dependent business to be successful, they’ll need to require as a condition of sale that the owner come work for the buyer for three to five years. This is called an earnout, and a percentage of the sales price for the business is held back and earned by the owner when they achieve agreed-to growth targets over time. Reducing your company’s dependence on you – the owner – will have an immediate impact on the value of your company, and it will allow you to get all or most of the sale price up front, which is significant.
If your business is dependent on any key customers, suppliers, or employees, you’ll raise an immediate red flag with buyers. Buyers have many questions they need answers to since they’re spending a lot of money to buy your business:
- Where do you source all of your products and inventory?
- Are you dependent on a key supplier and what is the likelihood that they raise prices or take longer to deliver?
- What if they walk away from you?
- What if a key customer brings in 40% of your revenue and decides after the sale of your business to take their business to a competitor?
- Will the buyer have to fire a lot of employees to get the operations in line with the reduced sales?
- What if a key employee leaves the company upon learning that the business has been sold?
- Is that key employee was your sales manager and sold the majority of your products and services?
These are all risks that buyers think about, and they will likely walk away from deals when they see these issues, or they’ll significantly lower their asking price to compensate for the risk.
Positive Cash Flow Engines
We say this a lot, and you’ve heard it before as an entrepreneur: “Cash is king.” Companies that bring in a lot more cash for every additional sale they make are very valuable and are sought after by strategic and financial buyers. These businesses can really scale and require a lot less working capital to operate, since they are flush with cash. Remember, you want cash coming in much faster than cash going out. When you’ve created a positive cash flow engine for your company, you’ll increase the value of your company, and you’ll attract buyers who hunt for these situations.
Remember to put on your buyer’s hat when you’re preparing your business for sale. All of the topics addressed above are key drivers of value that are important to buyers when they are looking for a business to purchase. Companies that are strong in these areas generally sell for more. So, you always have to ask yourself, “What is my business worth and how can I increase my value?” More on that later.