Most entrepreneurs have in their minds that at some stage they would like to move on from their business, make some money and do something else to fulfil their dreams. So how do you do this, and make sure that you get the best value for all your hard work?
What is your business worth?
In most entrepreneurs’ mind, the price for their business is vastly more than an objective value of the business might be, because all their energy, emotions and savings have been sunk into bringing this baby to life.
There are a number of ways of valuing a business, which can give a clue about its value, but ultimately it is whatever a buyer is prepared to pay. In general, the value of a business is based on what return on the investment an investor can expect.
A few common examples of valuation techniques are:
- Price/ Earnings Multiple – a multiple, depending on the business sector, size and risk profile of a business, is applied to the annual profit (usually EBITDA [earnings before interest, tax, depreciation and amortisation]). Typically for a small to medium sized business this would be between 3 and 6. So if you make a EBITDA profit of £300,000 and your multiple is 4, the value of your business is £1.2 million
- Payback period – an investor may simply look to see when he will get his cash back, after all costs have been extracted including corporation tax, personal tax etc. Typically, they might be looking for a payback of between 3 and 5 years
- Discounted cash flow – some investors will consider the investment as an opportunity cost. If they invest their money in your business, what will be the Return on Investment. How does this compare against other forms of investment in terms of risk and reward. They may typically require a return of between 15% and 20%, although in the current climate this may be less.
Ultimately, building your business for value is the right thing to be doing even if you are not thinking about selling, because it will maximise the return for you.
How to prepare for exit?
As we have seen from the valuation model above, there are 2 elements that make your business attractive to investors. How risky is it and how much does it return? You therefore need to consider these in every aspect of your exit strategy.
Ultimately, there are 3 key stages on the journey to exit.
Weaning A typical entrepreneurial business has required the heart and sole of the founders to build it to its current level. You need to wean the business off its reliance on you in the day to day operation of the business. You need to concentrate on working on the business and not in it. This is often called succession planning.
Youth Once you have delegated your responsibilities to others, they will begin to make decisions and strike out for independence a bit like teenagers, making mistakes along the way. In order to keep them on track, you need to be able to guide the business by implementing best practice throughout.
- Have you got frequent and accurate financial reporting?
- Do you have a 3-5 year business plan in place?
- Can you identify and measure the key business levers in your marketing, sales, and operations?
- Do you have a continuous improvement culture with your staff and do they have clear job specs?
- Etc etc…
Leaving home You are considering selling, and you need to manage the process to maximise the value. There are several things that you need to consider to get the best price from the buyer. This is about getting the business to be a finely honed racing machine.
- Offload superfluous assets and realise the cash.
- Reduce your working capital requirement by; * Tighten your stock and work in progress. Identify your worst performing products and manage them out. * Reducing your debtor days, through either negotiating better with your customers, or being better at your credit control * Increasing your creditor days. Try writing to all your creditors saying that you are increasing your terms by 15 days. Some will fight this, but some won’t!
- Make sure that your documentation and systems are fit for purpose, and could be managed by a new owner. Do you have an Employment Policy, Health and Safety Policy, proper processes and procedures for all the main operations in the business.
- Do you have a diverse customer and supplier base? Is the business too reliant on any third party.
- If the business is sensitive to its location, have you secured the premises through a long term lease or if you own it, whose name is it in? If you are not location sensitive, do you have short term commitments on your property?
- Take early tax advice about the structure of your business on exit. There may be some pension or other planning you can do to significantly reduce your capital gains tax.
- Make sure that your key employees are motivated to stay with the business.
Early on in the process you need to identify who might be your buyer. If you end up building the wrong machine, they won’t be interested. Don’t focus on one specific buyer, but identify the possible types first and then specific names – is it a competitor, a trade buyer looking for vertical integration, is it a foreign buyer looking to get access to the UK market or is it private equity looking to make a significant return on their investment.
Finally, probably the most important thing is to get someone to talk to in confidence that you trust. This really needs to be someone who has no tie to the politics of the family or business. This can be a very stressful process, and a problem shared….. well you know how it goes.