Why do you own a business?
It’s interesting to consider this because we are shocked at how many business owners haven’t taken the time to consider this fundamental question.
From a big picture perspective, having a business provides you with a lifestyle. That’s it!
It gives you cash now to fund your family spending, and hopefully a lot of cash in the future when you sell your business.
And it’s very similar to having a Self Managed Super Fund (SMSF), an investment property or share investments. They give you cash either now or in the future, or a combination of now and future.
Having a business, SMSF or an investment property is not the important thing. The important thing is what the cash you receive from owning these allows you and your family to do.
Your plans for what you do will do with your business, SMSF or investment property in the future are what we call your ‘end game’.
A good business mentor and friend of mind once taught me that “the point of having a business is to sell it – even if you don’t want to right now.”
This one pearl of wisdom could mean hundreds of thousands or even millions of dollars more for you in the future if you let it guide you now.
Here’s how… as you run your business, start to make decisions now to plan for selling it – even if you don’t plan to sell it for many years.
The biggest thing you can do is to make changes so that your business does not depend on you. If your business needs you to operate – can you really sell it? Absolutely not.
Setting up systems for your business is the key. You can then train your team to follow your systems, and then you can gradually delegate what you do to the right team members, and then you’ll find that you’ve got a business that can partially run without you.
How can you make your business worth a larger amount when you want to sell it?
Before we answer this question, remember: your business will only be worth what someone else is willing to pay for it.
So, you may think it is worth $1 million, but if your best offer is only $500,000, then $500,000 is realistically what your business is worth.
How can you attract a buyer and get them to pay the price you want?
A basic business value formula
Most small and medium sized businesses are valued using a business valuation method known as the “Capitalisation of Earnings” method.
This valuation technique works by taking the earnings (before interest and tax – referred to as EBIT) of a business and multiplying them by what is known as a multiple.
Business Value = Earnings before Interest and Tax (EBIT) x Multiple.
Working out the appropriate multiple is often the most difficult thing to agree on when valuing a business. For most of small and medium sized businesses, the multiple would be between 1 and 5.
For example: A business making an EBIT of $200,000 is assessed by an accountant to have a multiple for sale purposes of 3.
Business value = $200,000 x 3 = $600,000.
How to increase business value
Using the above valuation technique, there are 2 ways to increase your business value.
- Increase EBIT; and/or
- Increase the multiple
Increasing EBIT is all about your business making higher profits by improving efficiencies which leads to decreasing expenses, and then with a lean efficient business you can also start increasing revenue to magnify those profits and your EBIT.
Increasing the multiple involves making your business less “risky” to the buyer.
What the buyer is buying is a cashflow from your business into the future. If you can clearly demonstrate to the buyer that this cashflow is strong, is not expected to stop, and is expected to increase over time with business growth – then the multiple you can ask for will be higher.
Here’s a few things that will lead to less risk for your business, and therefore should lead to a higher multiple when you sell your business:
- Proper systems so the business can work without the business owner having to be there.
- Prove to the buyer the future growth of the business
- A diverse, expansive customer base (so the business doesn’t just rely on a few key customers)
- Contracts with key suppliers that will continue after the business is sold.
This information is just a general starting point to help you understand how to make your business worth more.
It doesn’t happen overnight. You need a 3-5 year plan to properly do everything needed to have your business sale ready.
Our expert accountants have had huge experience in this area. Contact us today for a free initial meeting with us, and we will give you a plan to make your business worth a lot more when you decide to eventually sell it.
General advice warning: The advice provided is general advice only as, in preparing it we did not take into account your investment objectives, financial situation or particular needs. Before making an investment decision on the basis of this advice, you should consider how appropriate the advice is to your particular investment needs, and objectives. You should also consider the relevant Product Disclosure Statement before making any decision relating to a financial product. These strategies don’t apply to everyone – our Wealth Advice Team must pre-qualify you to ensure you will be better off from these strategies and will then provide you with a Statement of Advice which clearly outlines our strategies and advice for you.