Thinking about selling your business? Having a target selling price is important, but finding a buyer who agrees with your valuation is crucial. To make sound financial decisions for your company, it’s essential to take a strategic approach to the process of selling your business.
Determine a Realistic Price for Your Industry
Setting an asking price for a business based solely on personal desires or needs may lead to potential buyers being scared off by an overpriced valuation.
To avoid this, it’s important to conduct industry research and gain insight into how sale prices are typically set. This will allow you to determine the average sale price range for a business similar to yours and identify strategies to bridge the gap between your desired price and the likely offer you’ll receive.
Understanding Business Value and Its Impact on Sale Price
The sale price of a company is determined by its business valuation, which depends on the industry and the valuation method used. The two common valuation methods are:
- EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a measure of a company’s profitability.
- A multiple of the company’s revenue.
The sale price will be a multiple of the company’s value, typically ranging from 3X to 10X. Your industry will have a standard multiple range used to set the sale price. Obviously, you’ll want to maximize the multiple you get when you sell your business.
Identify and Close the Value Gap
Once you determine the appropriate valuation method and sales multiple for your industry, you can assess your company’s current market value. If your desired sale price exceeds industry standards, you must explore options to narrow the gap.
For example, if you aim to sell your business for $10 million, but the industry average indicates a probable sale price of $5 million, you need to increase the value of your business twofold.
Increase Revenue and Profit to Bridge the Gap
Boosting your company’s revenue and/or profits is an effective way to enhance its value. Begin by ensuring that your existing revenue streams and profits meet or surpass industry benchmarks, and then seek opportunities to exceed those standards.
Expanding the recurring revenue of your business can be a potent way to increase its value, as it provides predictability and will continue to generate revenue after the sale. Monthly contracts for delivering goods or services are more valuable than one-time sales because they ensure recurring revenue.
Tip: Keep in mind that if your business valuation is based on EBITDA, your departure could positively impact the valuation. As the owner, your compensation package (including salary, benefits, and distributions) is likely higher than your replacement’s compensation package. For instance, if your compensation is $1 million and your replacement will be paid $600,000, the company’s value will increase by $400,000 due to the cost savings of replacing you.
Attract the Right Type of Buyer
Seeking the right kind of buyer can help you secure a higher sale price for your business. There are generally four categories of buyers you can attract:
- Strategic investors are interested in enhancing their existing business by providing the services and products your company offers.
- Financial buyers are often private equity groups. They aim to generate a high return and usually want to retain the current management team.
- Individual buyers seek income and freedom and prefer to buy small businesses with a proven track record to minimize risk.
- Industry buyers tend to acquire or merge with direct competitors to increase their profitability and economies of scale.
Buyer Perspectives on Profitability
The motivation of each type of buyer determines how much they’re willing to pay for your business, and the importance they place on your company’s profitability. For financial, individual, and industry buyers, profitability is crucial since they aim to maintain the business as is. They require assurance that it’s currently profitable and has the potential to keep growing.
Strategic investors are less concerned about your company’s profitability, focusing mainly on your Gross Profit Margin (GPM). Your Net Profit Margin (NPM) will be virtually insignificant. Since strategic investors already have operating expenses, your operating expenses (and therefore, your NPM) are of minimal importance. Their acquisition of your business is simply a means of quickly and easily increasing their GPM.
Suppose your company generates $10 million in annual revenue with a 40 percent Gross Profit Margin, which is $4 million. By purchasing your business, a strategic investor would add $4 million to its bottom line, even if your Net Profit is $0. For strategic investors, the absence of your operating expenses means they can count those funds as profit, making your business a valuable acquisition.
Strategic investors are generally more attractive potential buyers because they are willing to pay a higher multiple and are less concerned about a company’s profitability. For instance, a strategic investor may offer 8X, while a small business buyer may only offer 5X.
If you’re only attracting financial, individual, or industry buyers, consider approaching an established player in the industry. They may be willing to pay more and have better resources than a newcomer.
Strategic Approaches to Maximize Your Sale Price
You should receive a financial reward for the hard work you’ve put into growing your business. To ensure you get the most money possible, be strategic throughout the sales process – from setting a list price to maximizing valuation and finding the right buyer.
Want help determining the right sale price for your business – and seeking the right kind of buyer? Book a complimentary, no-obligation Financial Strategies & Solutions Session with one of our highly trained virtual CFOs to explore how we can help. We’ll help you accurately assess your company’s current market value, identify ways to increase its value, and explore ways to find a great buyer who is willing to pay maximum price.