If you have asked yourself this question at least 10,000 times during ownership, well, you are pretty normal. When it comes to exit planning, that is, after all, the million dollar question…or two or three or ten million-dollar question. You’ve heard various answers. It depends on your size, or your industry, or your profit margins, or asset value, or contract value, etc. Yes, it depends on many things, but who can study all those angles (besides our team at GAI!)?
I like principles: principles of living, principles of business, and principles of business valuation. Here is all you need to know when thinking about how to value your business:
BUSINESS VALUE = BENEFIT STREAM X PROBABILITY OF REPLICATION
This formula contains the two key principles utilized in business valuation. If you know what levers to pull to impact these, then you know what actions to take to increase the value of your business.
The term “benefit stream” is used to discuss the true benefit of ownership of the business. We’re talking, of course, about profit, but this is referred to in a variety of ways: earnings, EBITDA, SDE, etc. Bottomline, the bigger the benefit stream, the greater value someone else will place on it. So, your task is to determine what actions you can take to increase the benefit stream. Can you think of any? Keep it simple. Think revenue up and expenses down.
Probability of Replication
This principle addresses the likelihood that the business can replicate the benefit stream in the future. Said differently, how easy will it be to produce this year at least the same financial results produced last year? Subscription-based business models with automatic renewals are repeatable. Having a general manager in place with defined SOPs supports repeatable performance. Long-term supply contracts increase repeatability. Brand recognition and customer loyalty contribute to repeatability. The higher probability of replication, the greater value someone else is going to place on the business. Again, your task is to determine what actions you can take to increase or strengthen your business’s probability of replication.
When you increase the benefit stream and increase the probability of replication, the business becomes more desirable, not only to a potential buyer, but also to you as the owner. You will enjoy more freedoms and more financial rewards as you work to increasing the value of your business. At GAI, we will help you identify actions you can take to influence these principles.