Have you ever read those Top 100 Rich People lists and wonder how much you are worth?
It’s a question that any business owner should consider taking some time to explore. Many people work their whole lives without planning how much wealth they will need to accumulate to enable them to retire comfortably.
It used to be thought that $1 million dollars in super or savings would be enough. But depending on your lifestyle needs and your current age, that lofty sum may leave you woefully short.
So how do you find out how much your business is worth? Most businesses are valued based on a multiple of earnings before tax, interest and depreciation/amortisation known as EBITDA. In layman’s terms, this is your profit with some minor adjustments.
If you look at the financial pages of one of the broadsheets, you’ll see an entry for each stock traded under a column headed P/E. This refers to the Price/Earnings multiple. The table below provides a simplistic example:
|Shares issued||20 million|
|EBITDA per share||$5 (100 million/20 million)|
|P/E quoted in the newspaper||7|
So in this example, a stock trading at $35 means it is valued at 7 times the actual EBITDA it gets.
The problem is, privately held businesses almost always sell for lower P/E ratios than publicly traded businesses. In the real world, you might need to cut that rough valuation in half to 3.5.
Below are five key drivers of business valuation for privately held businesses:
1. Financial performance
If you are looking to sell your business, then this is the place to start. Ideally, you’ll want to give yourself 3 to 5 years to significantly improve the financial performance of your business. As I have highlighted in previous blogs, my bias here is to get very focused on the key drivers of revenue and profit, being:
1. Number of customers
2. Number of times per year that they buy on average
3. Average transaction value 4. Gross profit percentage
2. Growth potential
If someone acquired your business, would they have a clear path to growing your existing revenue? Do you have loyal customers who are keen to buy more? Are there opportunities to introduce new products and services? And generally, where is your industry life cycle? Many traditional industries are being wiped out as we speak by cloud-based technology.
3. Customer mix and spread
Are you overly reliant on a small number of large customers? If they stopped dealing with you, what would be the impact on your business? Ideally you want to cultivate a broad customer base where the loss of a couple of customers would not have a material impact on profitability and cash flow
4. Cash flow
Are you cash flow positive or cash flow negative? How quickly do your customers pay you, relative to the cash you need to send out to suppliers and to hold inventory?
5. Dependency on the owner
If you walked tomorrow, what would happen to the business? Where do the customer relationships lie — with you, or the business? How strong are your systems and processes? Could they be picked up by a new owner so that the business could thrive without you in the picture?
Recently, at my business’s annual conference in Queenstown, NZ, I was privileged to hear John Warrillow speak on just this topic. John is the author of the book Built t o Sell (http://www.builttosell.com/) and the creator of the Sellability Score.
John takes the key drivers I have listed above and more and condenses them into a 13minute assessment that will provide you with a succinct and very valuable report to help you understand where you need to focus your energy to increase the value of your business. I strongly recommend you take John’s assessment here (http://sellabilityscore.com/).
What am I worth?
The other consideration, of course, is your personal net worth. Whilst business value can be subjective (someone buying your business because it fits beautifully with their own business’s strategy might pay more than someone who is simply buying a stream of profits), personal net worth is much more objective.
Essentially, you look at your assets (what you own) and deduct your liabilities (what you owe). Take a look at this simple online calculator to understand your own personal net wealth (http://www.infochoice.com.au/distributions/ASIC/Calculators2010/FinancialPosition/in dex.asp).
If the result is not as high as you had hoped, then you need a wealth creation strategy. It is never too late to start. For help in growing your business, talk with a proactive accountant. They will be able to help you or refer you to a financial planner to discuss your personal wealth creation needs.