Have you ever wondered what determines the value of your business?
Perhaps you’ve heard an industry rule of thumb and assumed that your company will be worth about the same as a similar size company in your industry. We have found there are eight aspects that drive the value of your business, and they are all usually more important than the industry you’re in.
Not convinced? Let’s look at Jill Nelson, who recently sold a majority of her $11 million telephone answering service, Ruby Receptionists, for $38 million.
That’s a lot of money for answering the phone on behalf of independent lawyers, contractors and plumbers across America.
To give you a sense of how high that valuation is, let’s look at some comparison data. The Value Builder system has studied over 30,000 businesses in the last five years. The average value for companies looked at was 3.6 times pre-tax profit.
When they isolated the administrative support industry that Ruby Receptionists operates in, the average multiple offered for these companies over the last five years was just 1.8 times pre-tax profit.
Jill Nelson, by contrast, sold her interest in Ruby Receptionists for more than 3 times revenue.
There were three factors that made Nelson’s business much more valuable than her industry peers, and they are the same things you can focus on to drive up the value of your company:
- Cultivate Your Point of Differentiation
Buyers of companies do not buy what they could easily build themselves. If your main competitive advantage is price, an acquirer will rightly conclude they can simply set up shop as a competitor and win most of your price sensitive customers away by offering a temporary discount.
Ruby Receptionists invested significantly in technologies that ensured that no matter when a client received a phone call, that call would be routed to an available receptionist. Nelson’s competitors were mostly low-tech mom and pop businesses who often missed calls when there was a sudden surge of callers. The technology at Ruby Receptionists could handle spikes in phone calls because of the unique routing technology Nelson had built that transferred calls efficiently across her network of receptionists.
Nelson’s acquirer, a private equity company called Updata Partners, saw the potential of applying Nelson’s call-routing technology to other businesses they owned and were considering investing in.
- Recurring Revenue
Acquirers want to know how your business will perform after they buy it. Nothing gives them more confidence that your business will continue to thrive post sale than recurring revenue from subscriptions or service contracts.
In Nelson’s case, Ruby Receptionists billed its customers through recurring contracts—which made buyers confident that the company was there to stay.
- Customer Diversification
In addition to having customers pay on recurring contracts, the most valuable businesses have lots of little customers rather than one or two biggies. Most acquirers do not want any customer to represent more than 15% of revenue.
At the time of the acquisition, Ruby Receptionists had 6,000 customers paying an average of just a few hundred dollars per month. Nelson could lose a client or two each month without skipping a beat, which is ideal for reassuring a hesitant buyer that your company’s revenue stream is bulletproof.
Nelson built a valuable company in a relatively unexciting, low-tech industry, proving that how you run your business is more important than the industry you’re in.
How does the blender manufacturer Vitamix get away with charging $700 for a blender when reputable companies such as KitchenAid make blenders for less than half of that?
It is because Vitamix specializes in one thing, and they do it better than anyone else.
WhatsApp was just a messaging platform before Facebook acquired them for $19 billion US. Go Pro produces the best helmet mounted video cameras in the world. These companies stand out because they poured all of their limited resources into one big bet.
The term “goodwill” is often used in conversation as a subjective description of how much your customers like your business.
However, in valuing a business, there is nothing subjective about the definition of goodwill. It is the difference between what someone is willing to pay for your company minus the value of your hard assets.
Are you trying to time the sale of your business so that you exit when both your business and the economy are peaking?
While your goal to build the value of your company is admirable, here are five reasons why you may want to sell sooner than you might have planned:
If you have resolved to make your company more valuable in 2017, you may want to think hard about how your customers pay.
If you have a transactional business model where customers pay only once for their purchase, expect your company’s value to be a single-digit multiple of your pre-tax profit.
Most people think of starting a business as risky, but unless you invest a significant amount of start-up cash in your venture, you’re not really risking much other than your time.
That changes if you’re lucky enough to get your business off the ground. As your company grows, you start to risk more and more of your wealth because the business you’ve built is actually worth something. The longer you hang on to it, the more you have to lose.
You can now buy a subscription for most consumer products from dog food to flowers. Music subscription services are booming as our appetite to buy tracks is replaced by our willingness to rent access to them. Starbucks now even offers coffee on subscription.
Why are so many companies switching to a subscription business model? The main reason is that recurring revenue increases the value of your business, but there are some other, less obvious, benefits to add a subscription offering to your business.
When you put together next year’s financial plan, will your growth come from selling more to your existing customers or finding new customers for your existing products and services?
The answer may have a profound impact on the value of your business.