“What is my business worth?” This is easily the most common question we hear as we meet regularly with founders and business owners. It can feel arbitrary and confusing to put a price tag on something you are so close to and know so well. When we turn the question around and ask these founders how they would value the company, they often focus on where they are headed, the opportunities they are excited about, and the challenges they have recently overcome.
While all these things are important, when considering the potential sale or financing of your company, it is important to understand how investors (or buyers) are likely to attribute value and the factors they will consider most important. At the most basic level, investors are evaluating for risk and opportunity. Focusing on the following five categories may help you highlight opportunities and add value to an investor’s perception, which could result in a higher offering price for your business.
1. Efficient Operations
Investors want to see a company with a strong management team in place that has streamlined operations. If there are gaps in the company’s management (e.g., lacking a true CFO, CEO/founder wearing too many hats), investors may expect that they will need to hire to fill those gaps. For senior-level positions, this could represent a significant near-term expense for investors that can likely be reflected in a lower perceived valuation. A complete management team can also help with optimizing your operations, including implementing new technology, automating processes, or improving supply chain management. Solving these issues and realizing these efficiencies prior to a potential sale can mitigate some business risk, resulting in more value for you instead of giving investors a reason to devalue the business due to the potential expense of time and resources to solve those issues themselves. Investors would rather spend those resources and time looking for opportunities to improve operations and profitability.
2. Predictable Revenues
Investors look for indicators of predictability when considering where to invest their capital. Frequently they look for companies that have a history of stable revenue and steady growth. An investor’s valuation of your company is usually an indication of the risks they see in the business. Unpredictable revenues can result in more uncertainty and variability, which means more risk. Companies with stable and/or increasing recurring revenues, or a subscription model, typically receive higher valuations. Augmenting a consistent revenue stream can be achieved in several ways, for instance, implementing a subscription or contract-based revenue model or even expanding into new markets.
3. Diversified Customer Base
Another common risk that often results in devaluation is tight customer concentration. While it is great to have a couple of large, loyal customers, companies that rely heavily on a few large customers may be considered risky investments as any customer attrition can dramatically impact revenue and profitability. While managing a portfolio of many smaller customers, typically with a few large “anchor” customers, can be more time-consuming, it is typically a healthier model that will make investors far more comfortable. Expanding your customer base could involve targeting new markets or verticals, offering new products or services, or building stronger relationships with existing smaller customers. Diversification in customer demographics, geography, and sector are also a few ways to reduce the perceived risk of over-concentration.
4. Strong Growth
Ultimately, investors aren’t only concerned about downside risk—they also want to see growth potential. Investors are on the lookout for companies with strong growth potential so that they can scale the business and meet or exceed return metrics. By demonstrating a history of strong growth, which may involve highlighting your company’s year-over-year revenue growth or margin expansion, investors will have more confidence in the future of the business. Showcasing growth plans, such as expanding into new markets, developing new products or services, or acquiring other businesses will also help investors see a pathway to continued growth and profitability. If an executable and achievable growth plan is in place, investors could attribute value to this and may be willing to pay more.
5. EBITDA Margin
EBITDA is a company’s earnings before interest, taxes, depreciation, and amortization (or, more simply, net income before non-cash adjustments). It is an essential metric used to evaluate a company’s financial health. Many companies are valued using an EBITDA multiple. Since EBITDA is an indication of a company’s profitability, investors will usually pay more for highly profitable businesses. The higher your company’s EBITDA margin, the more profitable revenues are, meaning increases in revenue are more meaningful. Unless you are focused solely on revenue growth, it is important to improve your EBITDA margin by pulling levers that reduce costs and increase revenues.
Most investors have numerous acquisition opportunities to choose from. By focusing on these five categories, you can make your business stand out and also may decrease the perception of risk, which could lead to greater interest from the market and potentially a higher sales price.
