One of the greatest benefits of being a business owner is that you get paid (or can get, at least!) two ways. Once, when your business makes a profit and you take some of that cash as your reward for the work that went into earning it.
Then, a second time, when you sell the business to someone else and get paid for the work you already did to get it to where it is today.
For many business owners, it’s the second time they get paid that really levels them up from doing OK to doing really well. The year-to-year profits may pay them the same as a nice corporate job, but then being able to sell the business is where they really fund their retirement- or at least the next level up in their business journey.
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This only works, though, if your business is actually something you can sell. And it only is going to sell at all if you understand the value it has and why someone would want to buy it.
Here are some things that business owners sometimes think matter but that actually have absolutely nothing to do with the value of their business:
- How hard they worked
- How much they sacrificed
- How much they invested
- How much debt they need to pay off
- What their investors want to get out of it
- How much they spent on the location
- Their credit card balances
- How much they need to retire
- How much some person once said they would give them for it
- How much they read online a buyer might pay
- How publicly traded firms are valued
- What the business could do in the future if someone else put some money/time/effort into it
As much as getting paid that second time is great for business owners, the best way to ruin what that can be is to totally miss how the value works.
The common thread in most of what is listed above is it relates to what the seller wants or thinks they deserve. But as it turns out, the buyers don’t really care about that at all. Why would they?
The buyers are interested in what the business has done and could do for them. Just because you spent $500K in building out a location doesn’t mean a buyer should make you whole. Just because you owe $1.5M in an SBA loan doesn’t mean the buyer needs to pay you $2M so you can pay the debt and still walk away with something. The business may be worth $3M. Or it may be worth $100K. The value has nothing to do with what the seller needs.
Therefore, if you want to sell and get the most out of your second form of payment, you need to understand what buyers care about most and make sure your business is delivering that as well as it can.
What do buyers want most? First and foremost, they want profits. If your business is losing money, you really have nothing to sell other than any actual assets you own (trucks, equipment, etc).
If you do have profits, then the buyer is going to be open to buying your business for some multiple of those profits- regardless of what else is going on in the business. Suppose you have a business that makes $100K per year. A buyer will pay some multiple of that depending on their situation, the kind of business, etc.
It may be $200K or maybe as much as $300K. Now, what if in your business that makes $100K, you spent $500K building out the location. Should the buyer pay you for that also? Well, you’d like them to, but they aren’t going to do it. It’s not their problem.
They are looking at investing money to get a return between 33%-50%- reasonable for how risky a small business is. They aren’t going to pay $800K and accept a 12.5% return! Not when other businesses make the same $100K and only cost $200K.
Why would they spend so much more to get the same cash flow? They wouldn’t.
So as a seller, you need to understand what matters most in getting that second payment and then focusing your energy on building up that number so you, in turn, can get the best price. You also need to realize what isn’t part of that value, so you can keep your efforts focused and expectations reasonable.
There are a lot more things that go into having a successful sale and getting the best price, all of which help, but it all starts with and the biggest focus is on a multiple of profits. If you worked on nothing else, you’d be 90% of the way there.
In future newsletters, I will dive into other aspects of what drives value for selling a business, but I thought it equally important here to dispel some myths about value so no one is too disappointed or surprised later to find out what doesn’t matter!