business man contemplating exit planning

Is Your Business Worth What You Think It Is?

December 14, 2021

We have all been there – you see a nice sports car, fire engine red, and think to yourself, “Wow, what a beautiful car!”  What makes it a nice car? Just the way it looks, or does knowing there is a ton of horsepower under the hood also make it desirable? But what if you lifted the hood and that car had an old, weak engine inside? Is the car still as desirable? Maybe not.

That could be what a potential buyer thinks about your business! It could be free of debt and generate great cash flow, but a prospective buyer is going to look beyond the numbers. Sure, they will certainly look at how the business performed while you were the owner, but what they are most concerned with is what they’ll be receiving after the transaction closes. What is transferred to them? A buyer will not purchase your business based on past performance alone – they will buy your business because of what they will be receiving after the deal closes! Here are a few things to think about when gauging the transferability of your business:

  1. Owner dependence. A big red flag for a buyer is if the business is too dependent on its owner. Many times, the owner runs the business, brings in most of the new revenue, maintains key relationships, among other things. If the business is too dependent on the owner, how will that impact business operations once he or she separates from service? If the owner is not around, how will that impact business development or key business relationships? If the business cannot run without the owner, what exactly is a buyer receiving? Getting the owner out of business operations can increase business transferability and actually increase business value!
  1. Management succession. In a buyer’s eyes, another potential issue is the absence of key managers to succeed the owner. Many times, the owner will stay on post-transaction to help with the transition to new ownership. Having a solid management team around the owner pre-transaction can be a huge plus to a buyer. These key employees can help ensure a smooth transition and continuity of business operations after the sale. The absence of a solid management team could result in a rough transition as it relates to operations, employee morale, and relationships with business partners. It goes without saying that a high-quality management team around the business owner will drive business value.
  1. Customer concentration. The sales numbers in your business may look great, but if too much is derived from one customer, that presents a risk to the buyer. If that customer leaves to go to a competitor, the buyer would be in big trouble from a revenue standpoint. If possible, it is ideal to have a diverse customer base where each customer does not account for too much of company sales. If this is not possible, putting some sort of customer contract structure in place can help mitigate some of that risk for the buyer.
  1. Owner’s personal plan for exit. According to the 2013 State of Owner Readiness Survey, 75% of business owners regretted selling their business within one year post-close. Further, only 4% of business owner respondents mentioned having a formal, “life after business” plan in place. Not only is having a “life after business” plan important for the owner, but it can also be important for a buyer. This personal plan increases the chance that the owner will live a full, meaningful life post-transaction close and can reduce the risk that the owner will get cold feet and back out of the deal as it progresses.

Many people use the following phrase to talk about exit planning: “the first thing you do when you start a business is think about how you’re going to get out.” Of course, there are plenty of things to do when starting and running a business but exit planning should always be top of mind for business owners. Working on the above items today will help minimize risk and improve the value of your business.