Although you may be earning a good living from your business and a satisfactory mix of salary and dividends, it’s worth pausing to take stock in the growth in your business. You want to ensure that you’re looking ahead and building future value with, for example, new product lines and expansion. This is important for attracting new business and new employees.
It’s also a good idea to measure the value of your business. It’s never too early to consider how much your company is worth, especially since business owners always face this issue when considering selling their company. I like to tell clients that value is driven by two general factors: the quantity of your cash flow and the quality of your cash flow.
The quantity of the cash flow is easy to figure out — simply look at how much cash flow you generate from your business. That number will be a function of how fast you’re growing, how strong your competitive position is, how fast your underlying market is growing, and how much capital reinvestment you require in order to grow. All these factors will dictate how comfortable a potential buyer would be with the quantity of cash flow that your business generates.
The other factor is the quality of that cash flow. For example, cash flow that’s generated from a 10-year government contract would be very strong quality cash flow with high visibility, meaning that it is easier to predict how much revenue will be earned in the future. On the other hand, cash flow generated by a construction business, which is project-based, may be more volatile because future revenue is less certain.
To get a better handle on the value of their company, business owners can also do what is called a notional valuation. This is when a theoretical value is determined for your company by looking at comparable companies in the market. For example, try looking at what public companies in your industry may be trading at, or for what companies in your industry have been sold. In a private company space this can be difficult information to obtain. Industry benchmarks may be helpful where comparable sales can’t be found.
When it comes to increasing the overall value of your company, it’s about increasing the quantity of your cash flow — with new contracts, new territories, expansion initiatives, new products and services. Likewise, you can increase the quality of your cash flow by formalizing relationships, securing long-term contracts, building your management team (to reduce personal goodwill) or pursuing initiatives that bolster or secure your competitive position.
If you’re successful increasing your company’s value, the next question might be how to realize on it. To realize the maximum value for a business, it’s essential to properly plan from a strategic, operational, tax and overall housekeeping perspective prior to a sale, including knowing the tax positions of you and your purchaser before you enter serious negotiations to realize the maximum value. It’s also important to market the business correctly and talk to many potential buyers. Finally, it’s about designing a competitive process that will create the highest value.
It can often be tricky to get a true sense of what your company is worth. The harsh reality is that value is often in the eye of the beholder and you will have to showcase your business value to potential buyer. However, if you have a company that’s the right fit, a buyer will pay a premium for your business.