If you're a retiring small or medium-sized enterprise (SME) owner, one question is likely on your mind: "How can I maximise the value I get from selling my business?"
The valuation process can seem complex and arbitrary, influenced by a multitude of variables.
In this article, we will provide insights from an investor's perspective on how to maximize your business valuation. We'll delve into some of the key factors that impact valuation and outline steps, which we have seen used in other SMEs, you can take to enhance it.
Factors Affecting Valuation
When considering business valuation, it's crucial to acknowledge the myriad of variables that come into play. These can include industry trends, economic conditions, market competition, and more.
At Firebird, however, we believe that several core factors have the most significant impact on valuation.
1. Natural Successor
A natural successor is someone capable of assuming leadership within your business.
Most SMEs have individuals capable of managing day-to-day operations, which is great as it reduces the risk of the deal for an investor i.e.: the business can continue current operations, even when the business owner steps back from the business.
However, to secure a higher valuation, you must instil confidence in investors regarding the future leadership of the business:
Leadership Potential: Ensure there is someone capable of not just operating but also leading and growing the business.
Experience: The successor should have a track record that demonstrates their ability to deliver results.
Competitive Compensation: The successor should be on a market-level compensation package so as to minimise the risk of them leaving after a deal is done. Internal promotions often fall short in this regard.
To maximize valuation:
Delegate Authority: Develop a team that can run day-to-day operations independently.
Plan Transition: Prepare for a leadership transition, either through internal promotion or external recruitment.
Time for Success: Allow the successor sufficient time to prove their effectiveness.
2. Customer Concentration
Customer concentration refers to the percentage of revenue attributed to your largest customers.
Frequently, an SME is founded and grows quickly through close relationships with a small number of customers. This is a positive aspect, as it shows that the service offered is valuable. The contrasting viewpoint is that overreliance on a few key customers places risk on the success and stability of the business, which may negatively impact valuation.
No Fixed Rule: There's no fixed threshold for what constitutes "high" customer concentration, but Firebird Capital considers more than 50% of total revenue from the top three customers as high.
Addressing Concentration: Mitigating customer concentration takes time. Invest in Sales and Marketing to broaden your customer base, reducing reliance on individual clients whilst also growing your revenue and profit levels.
Deferred Consideration: If there is a desire to sell your business while customer concentration is still high, one way to negotiate a higher valuation is to accept a portion of the value being deferred (sometimes known as Deferred Consideration or Earnout).
3. Revenue Visibility
Revenue visibility refers to the predictability of revenue. There is deemed to be visibility where there is a level of contracted or repeat revenue.
Investors place a high value on revenue visibility because it reduces the level of risk associated with a transaction, as it provides a predictable stream of future income.
Target: Again, there is no fixed threshold, but Firebird Capital targets businesses that have more than 50% of revenue from contracted or repeat sources.
Steps to improve this are highly dependent on the type of business, but some common methodologies include:
Tracking data to give an accurate depiction of the level of repeat/contracted revenue
When negotiating with clients, consider pushing for multi-year contracts in return for a discount/additional product.
Offer discounts/additional products to repeat customers.
4. Historic Performance
The valuation of a business that can demonstrate consistent bottom line growth tends to be higher than a business with erratic performance. The underlying reason is that an investor only makes returns on future performance, so showing that there is stable historic performance on which to build can encourage them to offer a higher valuation.
Timing Matters: Consider delaying the sale until you can showcase consistent growth over several years.
5. Growth Opportunities
Presenting vague growth ideas can hinder your valuation. Investors prefer specific, tangible, and achievable growth opportunities.
Credibility Counts: The business gains value if it has already initiated growth opportunities, indicating credibility and untapped potential.
Maximizing your business valuation is a strategic process that involves focusing on key areas that matter most to investors.
Whether you're grooming a natural successor, addressing customer concentration, enhancing revenue visibility, demonstrating historic performance, or presenting concrete growth opportunities, each step contributes to a more favourable valuation. As you prepare to transition and secure the future of your SME, remember that investing time and effort in these critical areas can make a significant difference in the final valuation you receive.
Ultimately, your business's worth is not solely determined by its past but by the promise it holds for the future.
At Firebird Capital, we have built a valuation tool that takes account of some of the aspects mentioned in this article. Click here to use it.