Key Drivers to Business Valuations and How to Maximize Proceeds

business valuations

If you’ve been an entrepreneur for more than a couple of weeks you’ve no doubt heard about business owners building their companies to sell or about how someone you met at a conference with a shiny watch “exited their previous company.”

Selling a company is the pot of gold at the end of the rainbow that many business owners aspire for. As business owners who are planning to sell in the next decade embark upon their strategic initiatives and create their business roadmaps, building their business to optimize its value should be at the core of the decisions that they make.

In this article we will touch briefly upon how businesses are valued both quantitatively and qualitatively as well as touch upon who various buyers are, why they are interested in your business and how they may value your business differently.

While there are a number of valuation metrics that are thrown around, it is important to understand that it is buyer competition that will determine the ultimate value of a business. The process of marketing the business to get multiple bids from private equity firms and other investors is called an M&A auction process. It is typically conducted by an M&A advisor.

Business Valuation 101 – Part Art, Part Science

The most important factor when valuing a business is the financial performance and trajectory of that company. Stacking a companies performance up against it’s peers and industry benchmarks can yield some insights into how the company is performing relative to it’s peers in the space. 

Additionally, some industries are more attractive to investors than others. A few of the elements that make an industry more desirable to private equity groups and other asset managers are:

  • Non-cyclicality – industries such as healthcare that are always in demand are more desirable than cyclical industries such as consumer discretionary and new home construction.
  • Wide margin – wide margin is indicative of differentiation of the product or service. 
  • Recurring revenue – recurring customers and clients that don’t drop off are much easier for investors to get comfortable underwriting the companies future performance.
  • Scalability – If your business is in a small TAM and is not scalable, that makes it less desirable than a company that has plenty of room to scale.
  • Industries that are being rolled up – Many private equity groups look to grow by acquisition. This means they buy one large company (a platform) and many smaller ones in the same industry (bolt-ons) to combine with it, thus growing the portfolio.

So Is It Just Financial Performance That Contributes to Value?

Not at all. Having a strong management team that is well incentivized and has tenure with the company makes the business much more desirable to buyers and investors. While it is difficult to hone in on exactly how much of a premium a business gets for having a proven management team in place, talking to any M&A advisor that has significant experience and they’ll tell you the same thing, that a backable management team is valuable and gets buyers comfortable paying a premium.

So How Do You Get a Valuation for Your Business?

There are ‘rules of thumb’ to value companies in a number of industries. However, they are not accurate enough to use when taking your business to market. If you’re looking to raise growth capital or sell your company, interview a few investment banks (for companies over $100m revenue) or M&A advisors (for companies under $100m revenue) that have had success in your space. If your business is worth taking a look at, they can give you some insight on who the potential buyers would be and at what valuation.

Raincatcher has also put together a free business valuation calculator. While the tool is structured to gather information quickly, it will still take a few days for the advisor that focuses on your industry to get back to you with their thoughts on value.

get a valuation for your business

What Can You Do to Increase the Value of Your Company?

Many of the factors that make your company more valuable are the same elements that will make you want to keep it, being as though it will be more profitable, predictable and be less of a drain on your time as the owner-operator.

Some of the elements that make your individual business more desirable to buyers and investors are:

  • Scale – larger businesses are more desirable than smaller ones.
  • Lean operations – High margin and return on human capital
  • Strong team in place – As mentioned above, a tenure management team that runs the business for you is desirable.
  • Asset light – Lean, professional service companies are more desirable than asset heavy companies with high maintenance capex.
  • Differentiated – This could be a highly engineered product or niche software product. Something that gives your company a competitive advantage.
  • Not relationship dependent – If YOU as the owner personally drive business based on your reputation and expertise, that makes your business less desirable unless you are interested in sticking around and working for a year or more.

What Else Should You Know about Selling a Company?

For many business owners, the opportunity to sell is once in a lifetime. Additionally, the majority of your family’s net worth is tied up in your business. If you have an exit planned in your future (even if it’s 3 or more years out), it isn’t too soon to think about an exit strategy and how to optimize your business for an exit.

While elements of your business such as the industry and geography that you operate in are already set in stone, there are typically a number of other factors that you can address to make your business more desirable to investors and some of those elements will take years to implement.

selling a company

What Size Companies Are Sellable?

While it is technically possible to sell a business of any size, the unfortunate reality of selling small companies (under $500k profit) is that there oftentimes isn’t a buyer. Some of these companies are not overly reliant on the owner (sizable restaurant, blog, small saas company, etc.) and those businesses will often-times find a buyer. However, if you spend your days working in the business instead of on it, it is hard to find a buyer who is willing to buy themselves a job.

Companies $1M+ in profit start to become more desirable to investors. While these will still be evaluated on a basis of how scalable they are and how much input is needed from the owner. As the companies get larger they become more attractive to the thousands of private equity groups who invest in the lower middle-market. Many of these PE firms (and similar investment groups such as family offices), start taking interest in companies with $2M+ in EBITDA and even more take interest in the $5M+ range.

Who Buys These Businesses

Just like there is a range of what a business is worth based on the size it is and industry that it is in, there is also a range of who the likely buyer will be. 

Small Businesses (Sub $1M Profit)

This is historically a very illiquid segment of the market, meaning that many businesses that are listed for sale won’t ever get a reasonable offer. However, those that do sell (about 35%) will sell to other solopreneurs, career changers or small business owners. It is also possible that if the business is in a desirable industry such as SaaS or e-commerce that there is more appetite for it on behalf of small investment groups.

It’s also worth noting that some industries that are being consolidated through a rollup by private equity groups will end up selling quicker and at a higher multiple. A rollup is when a PE firm buys one large business ($5M+ EBITDA) in a given industry and then buys a number of smaller ones to bolt-on to that larger one, thus consolidating the industry.

Lower Middle Market ($1M – $15M EBITDA)

Larger companies are more desirable for investors and sell at higher multiples. Companies in the lower middle market should sell with an investment banker such as Raincatcher and do so in a competitive auction process. This process pits business investors against one another to get multiple bids and the highest and best terms for the deal.

The buyers for these middle market companies end up being private equity groups (~70%), family office investors (~15%) and strategic buyers such as competitors, customers, suppliers, or any other business that has synergy with the target company (~15%).

Middle Market ($15M+)

This is a more efficient, liquid segment of the market. Companies this large will sell from one private equity group to another. On certain occasions, they may even be sold to a publicly traded company or go public themselves.

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About The Author

Mark Woodbury is a partner at Raincatcher, an industry agnostic lower middle-market M&A firm and business brokerage. Mark leads the teams initiatives in working with digitally native companies such as SaaS, eCommerce, marketing agencies and othe tech-enabled service companies.


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