Part 2: Improving Your Business’ Valuation
Metrics to Better Manage and Improve Your Business’ Value
Business valuation is not an exact science and the business is ultimately worth what someone is willing to pay for it. The quality of your customers, employees, longevity, the industry, the IP, and many more factors go into considering what the value of your business is.
Needless to say that with all these variations, the market needed a common language to transact with. So, the mergers and acquisitions world talks in multiples of EBITDA to describe valuation. EBITDA, earnings before interest, taxes, depreciation, and amortization, is a popular metric because it is a close approximation of the cashflow of a business.
Business Valuation = Multiple Applied X EBITDA
It helps to conceptually understand why these metrics are used. This post will focus on EBITDA as this is more directly in your control (we will discuss multiples in next post).
EBITDA is a proxy for the amount of pre-tax cash flow the business generates. The cash flow will ultimately determine how the buyer can finance the business and what their return on the investment will be.
Therefore, the most straightforward way to improve your business’ valuation is to improve your EBITDA. It naturally follows that the bigger your EBITDA, the more your business will be valued at, all else equal. But not all EBITDA is created equal and you can in fact improve the quality of your EBITDA.
Below are some general guidelines to improve the quality of your EBITDA:
Clean up your financials. Clearly start defining what the true operational financial profile of your business is and what it might look like if someone else ran the business. If your financials are messy you will have a tough time explaining various line items and a tougher time building confidence with buyers. My advice is don't cut corners with your accounting firm and as you approach the sales time, hire an accounting firm with M&A experience (and lawyers).
Improve the predictability of your sales. You can increase the predictability of your sales (also called revenue) by signing up your customers for longer-term contracts. You already have loyal customers so sometimes just the exercise of formalizing that relationship into contracts can greatly increase your valuation. If you cannot get the customers to sign up for contracts, make sure your customers stay loyal and increase their spending with you over time. Start measuring your customer churn, revenue churn, attrition, and growth. The goal is to increase your recurring or repeat revenue and to reduce your customer churn.
Define your growth formula. Many entrepreneurs reach a plateau in growth because they are often their company's number one salesperson. Sales grow opportunistically, through word of mouth or reputation. But as an owner and entrepreneur, you simply have too much on your plate to do this effectively full time. More importantly, the buyer will worry that after the sale they will lose the number one salesperson.
Strive to make an organization that is a self-enforcing growth machine. Invest in your sales and marketing and make growth formulaic. Start measuring your Customer Acquisition Cost (CAC), Customer Lifetime Value (LTV), and develop a growth formula to strike an optimal balance between CAC, LTV, and sales growth.
“You can’t manage what you can’t measure,” Peter Drucker, Father of Modern Management. Much of the advice above focuses on the better measurement, which is the first step towards better management. Powered by software and near-infinite computing power, measuring all aspects of your operations can be a low hanging fruit that provides invaluable insights to your business. These insights can be used to improve your sales, EBITDA, and ultimately your business’ value.
Need some help getting started with what and how to measure? Contact us.