October 13, 2020
How to Increase Value of a Business – Value Drivers Part 3
To conclude our three-part series on key value drivers, we discuss how to increase value of a business and the winning strategies owners can take.
While it may sound like an arduous task, some of these strategies may simply require employing a different mindset and perspective in solving the value puzzle.
How to Increase Value of a Business Through Revenue and EBITDA1
Perhaps the most obvious and one of the most important strategies for how to increase value of a business is good revenue and EBITDA levels, which can have a direct impact to the business value.
Some of you may overhear that a company got an “x” times multiple for its business. This means that the business achieved a selling price equal to a set multiple of their earned revenue and/or EBITDA.
For example, a company having a 3.0x multiple on revenue and 7.0x multiple on EBITDA means the owner will receive three dollars on every dollar of revenue earned and/or seven dollars on every dollar of EBITDA achieved upon the sale of their company.
While admittedly growing top-line revenue may be challenging, especially given the current economy, business owners can focus on bolstering their bottom lines (i.e. EBITDA).
As a first step, owners should focus on eliminating any discretionary or personal expenses that are unrelated to the business. Doing so would not only help preserve cash in the company but also present to a future buyer the true cash flow generating ability of the business by way of its EBITDA margins (i.e. EBITDA taken as a percentage of revenue).
When revenues recover back to pre-pandemic levels, the level of earnings that will flow through to the business owners will be the company’s revenue multiplied by its EBITDA margin, all else being equal.
Management Team and Streamlined Processes
It is prudent to learn how to increase value of a business by streamlining your processes and having well-trained staff.
Many businesses attribute a considerable amount of value to their staff, for good reason. While most small to mid-size businesses rely significantly on the owners to run the day to day operations, this may end up hurting the valuation in the long run. As a prospective buyer would not expect the existing owners to stick around for long after the sale, the know-how and relationships the owners hold will effectively need to be transferred either to staff or the new buyer prior to the owners’ exit.
We often see this in a sale agreement whereby the owners have a set transition period of 1 to 2 years to help migrate the business to the new buyers.
Having a trained management team and streamlined process in place helps alleviate the buyer’s fears that only the owners hold the key success factors in the business. In this sense, the business will be expected to continue operating and grow like it did in the past even when the owners leave.
Diversification of Client Base
If the business is reliant on only a handful of customers, buyers will perceive the business to be riskier than a business that has a well-diversified client base.
Similar to investing, having all the eggs in one basket may mean severe downside risk when the business loses a customer. Having a well-diversified customer base enables the business to be better adjusted to losing a customer as it would not be expected that this will cause any major disruptions.
How to Increase Value of a Business Using Your Competitive Advantage
Based on our experience, the highest price offered for a business is usually made by the company’s direct competitors or customers.
Competitors would usually offer a higher price in order to gain market share and expand its geographic reach while eliminating competition in the area.
Customers, on the other hand, would be able to vertically integrate the company’s product(s) and/or service(s) with their own and in doing so, have greater control over its value and supply chains.
These advantages are commonly referred to as synergistic benefits. The higher the level of synergies perceived by the buyer, the higher the offer price will be.
Factors owners should consider prior to the negotiation process:
a. Identifying the competitive advantages the buyer will receive when acquiring the company.
b. Estimating the quantum that the buyer is willing to pay to acquire these advantages.
Sell Your Strengths and Celebrate Your Milestones
Piggybacking off the previous point, most owners have spent a large part of their career building their business empire. With this comes a sense of pride and accomplishment but how can you use this to increase value of a business?
The goal is to now translate these achievements into selling points:
- Illustrate the strengths and competitive advantages the business has thanks to the valuable contributions made over the years.
- Plus, highlight those business milestones that led the company to be where it is today.
Providing a narrative of the business history and where the next milestones are will help the buyer understand the business further and share a common goal going forward. This will also translate to a higher price if these envisioned goals are aligned with the buyer or the buyer’s own existing business.
We Are Here to Help
Manning Elliott is here to help. To assist business owners and professional advisors, visit our blog to stay up to date on the most recent valuation topics.
1Earnings before interest, taxes, depreciation and amortization
If you have any questions on how to value your business at this time, please contact William Tam, CPA, CA, CBV directly.
This content is believed to be accurate as of the date of posting. Canadian Tax laws are complex and are subject to frequent change. Professional advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.