Asking what your business is worth is asking the wrong question
Your business valuation is not simply an accounting formula. It’s the culmination of a series of strategic moves to grow your business as an asset and to connect with your personal goals.
Exiting your business is a given. At some point, for whatever reason, you will part ways with what you’ve built and grown. This should be welcome news. Building a sustainable, profitable business is your pathway to being able to live the life you want. Getting there requires you to have achieved two goals: one, you know when, why, and how you want to exit your business. Two, you are getting maximum financial value out of your business asset.
The first issue of your exit strategy, including succession planning, deserves a deeper dive. We’ll address the second point here because it can kickstart the thinking around your exit strategy. A business asset with increased value gives you options for your choice of exit, be it drawing and income, retaining equity, or staying connected to the business after a sale. Business valuation is also a series of strategic moves.
Business valuation is more than profit
There are several models or formulae for business valuation, depending on the nature of the business and its ownership structure. The most straightforward format is this:
Total Equity Value = Profit x Multiple
This formula multiplies your profit by a benchmark for each industry sector, usually between two and 10-plus, based on industry standards and issues such as prevailing market conditions. Most advisors will see the industry multiple as fixed and want to drive profit to increase the sale price of a business. We are much more interested in driving the multiple.
The other side of the equation
“But I can’t simply change industry”, you say. No, but you can unlock value beyond simply what your business does. To illustrate the effectiveness of driving the industry multiple, think about buying and selling homes. The value of a home is based on its features, location, and market conditions. While you can’t change location or the economic climate, a good ad campaign or a savvy negotiator can undoubtedly make a difference in the sale price, much like driving the profit side of the equation.
Yet, as any real estate agent will tell you, modifications or improvements to the property will attract a higher price. That is, you can modify the features or structure of the house to put it in front of different buyers. Similarly, Stellar has developed a set of principles that can increase your industry multiple and your profit. These principles are part of the Asset Improvement Elements for Valuation framework. Adding layers increases the worth of your business by a particular multiple, as shown in the diagram.
Start bottom up
The first layer is based on the fact that many prospective buyers are looking at the value of your existing clients and your revenue. Here, we haven’t shifted the dial. Let’s move through the layers that add value and the strategic actions you need to take to reach each level.
Operational layers
+ 2 – Culture, capability, RGBY
This level and the next is where you have a functionally efficient business with a clear purpose, values, and strong client relationships. The business functions largely independent of you, and you focus more on strategic matters. At this level, the benchmark can improve
Action: Defined and shared vision, values
+ 3 – Systems and innovation
Most businesses sold for a decent sum are profitable, functional, and well structured – sit at layer two. They do something well and have effective processes and systems that are unique or better than competitors, for example, in IT, marketing, sales and training.
Action: Undertake a functional structure review and revenue project
Strategic layers
The following layers are strategic choices and drive valuation more effectively than increasing profitability.
+ 4 – Product extension
Do you know what you sell, and the reasons clients buy? At this level, you have diversified products and have shown that you can develop new products or repackage your product mix to increase revenue.
Action: Develop a product strategy
+ 5 – Channel extension
Sell more things, or sell one thing to more customers? Channel extension is about opening up new markets or deepening existing markets. You have established networks and a distribution strategy because having more channels to market adds considerable value to a business.
Action: Develop a distribution strategy
+ 6 – Brand
Your brand is more than your logo and colours. It is how you position your business in a way that speaks to the collective experience of why people choose you over a competitor. A distinct brand or a brand-led business with strong market positioning dramatically increases the desirability of your business over a business with no brand depth or meaning.
Action: Develop a positioning strategy to underpin your brand
+ 7 – Scale
The ability to sell a product repeatedly in multiple markets puts you in the highest multiple. This is true scalability and goes beyond hiring more staff. It can be challenging for traditional professional services industries, but scalability unlocks immense value.
Action: Undertake an IP review to unlock real value and potential for scalability.
Document progress
Each of the above layers requires a project to review, develop a strategy, and implement changes. This may require outside help, which is Stellar’s specialty. The final piece of the puzzle is that whether you do it yourself or with help, establish a formal record of strategic development and implementation progress. This will be the company “logbook”, the proof that outlines the layers of valuation and what could be a priceless document when negotiating the sale of your business.
To learn more about what drives business equity value, download our free eBook More Time. More Revenue. More You.