Guest post courtesy of Acquira.
If you’re looking to sell your business, there are several key factors that potential buyers will want to make sure are in place – factors that can dramatically improve the multiple that your business will sell for.
These can include having a management team, a strong company culture, favorable demographics, and recession resilience.
You should also avoid having key person risk and customer or vendor concentration. In this article, we’ll go over how to implement these changes and navigate these potential pitfalls.
Moving the EBITDA multiple from 3X to 5-6X
Most businesses that generate $1 million or less in EBITDA (earnings before interest, taxes, depreciation and amortization) are usually owner-led.
There is one person who has to wear many hats – from sales to finance to training to project management, to name a few. The owner has very little time outside of the day-to-day operations to plan for the future and really grow the company.
In general, these types of businesses will sell for a maximum 3X multiple.
This is because it can be difficult to transition to a new owner because the current one is central to everything and isn’t easily replaced.
They are also much too small for financial buyers like private equity to consider.
A business that generates $2 million in EBITDA, on the other hand, is almost certainly management-run.
There is a leadership team and mid-level managers who oversee all aspects of the operation. There are standardized procedures, job descriptions, and electronic systems. It’s relatively easy to transition to new ownership.
Businesses like this will usually sell for between 5-6X.
So, if you’ve got the first business, you can expect to sell it for $3 million today. If, on the other hand, you had the second business, you could expect to get as much as $12 million for it – a $9 million difference.
So, by getting a management team in place and doubling your EBITDA, you can dramatically increase how much you can sell the business for.
“That’s a big deal, right?” says Hayden Miyamoto, CEO and co-founder of Acquira. “How can you spend the next two to three years working on it so that you can exit it for 12 million in two to three years?”
Let’s look at some of the factors that go into determining whether your business will sell for 3X or whether it will sell for 6X. And how you can put steps in place to move to the latter category.
1. Management depth
Your business will command a larger multiple if it has an effective management team that can operate the business without you overseeing the day-to-day operations.
This includes both a leadership team and mid-level managers in customer-facing roles. This will give you time to reflect on key performance indicators (KPIs) to help drive improvements.
This is a big step for moving from a 3X business to a 5-6X business. It will also give you the time to work on some of the other factors discussed below.
This is probably the most important step you can take to improve your business so that you can maximize the purchase price when you eventually make your exit.
2. Company culture
One of the best indicators of a healthy business is a strong company culture, which helps performance and fuels future growth.
You want your business to have a close, familiar culture that has a healthy work ethic and a low tolerance for gossip and griping. A strong company culture will also include a strong connection to the local community.
One way to measure company culture is to look at employee tenure. Potential buyers want to see average tenure between three and six years, the more the better.
They want a business with happy employees who enjoy working at the business and are likely going to stick around.
They’ll look unfavorably if your average tenure is less than three years.
Another measure is to look at employee turnover compared against an average for your industry. If you have less turnover than other HVAC businesses in a 12-month period, your business will likely garner a higher multiple when you go to sell.
Looking at the demographics in the geographic area of your business is another important factor in assessing how much your business can sell for.
You’ll want to look at your total addressable market as well as the potential for growth over the next decade.
Is your business the major player in your industry or are there several firms all of a similar size? Is the population growing or are people moving away?
“If you are the big fish in a tiny pond, buyers will find that less exciting than a small fish in a big pond,” says Hayden.
In the former case, it’s more challenging to grow the business further without the market itself growing larger through demographic change. Without that kind of growth, you could be at risk of losing market share to another startup?
The opposite is true in the latter case, where your business has a much larger potential for growth by doing exactly that. This is much more enticing to a buyer and so will generally command a higher multiple when you sell.
4. Financial trends
Another key consideration for potential buyers is the overall financial trend of your business.
The first factor is whether things are trending upwards? Is revenue going up? Is your EBITDA going up? Is your gross profit going up?
You’ll also want to look at your business from a margin perspective. Is your gross profit margin going up or down? Is your EBITDA margin going up or down?
If you’re hoping to get the maximum value out of your business, you’re going to want to grow gross profit by increasing sales volume, increasing prices, or decreasing the Cost of Goods Sold for each unit of revenue.
Ideally, you’ll want to be thinking about doing all three.
The seasonality of your business – and the degree to which you’ve offset it – is another important factor in determining what multiple you’ll get when selling.
Many home services businesses like HVAC or roofing are particularly prone to seasonality. It’s common that you might have four months where sales are down by as much as half compared to the other eight months, for example.
You can mitigate seasonality by cross training your employees in other fields or offering secondary services.
You could train your HVAC technicians to perform basic plumbing tasks in the winter months, for example.
Or if you own a roofing company, you could move into basic renovations during the offseason.
Having these additional services in play already will make a seasonal business much more attractive to a potential buyer because they don’t need to implement these systems.
6. Customer or vendor concentration
Let’s say you have an HVAC company that does all of the work on a local restaurant chain, equal to 15 percent of all revenue. Perhaps it’s based on your personal relationship with the chain’s owner.
A potential buyer will likely see this as a risk because they will be worried of losing that contract once you’ve sold the business.
The same can be said of any customer or vendor that accounts for 10 percent or more of your business.
You’ll want to mitigate this risk – and, thus, increase the overall value of your business – by increasing sales to other customers so that no single customer accounts for 10 percent of revenue or more.
Buyers will often create specific deal terms if a business has customer concentration by offering to pay 80 percent up front and the remaining 20 percent after a year if the key customer is still using the business.
7. Key person risk
Like the customer or vendor concentration, buyers will be leery of a business that has one key person that the business depends on.
Perhaps there is only one person who does estimates or there is a single employee who has an HVAC master license, for example.
It could be catastrophic to the new owners if that person were to leave the company.
One way to mitigate key person risk is to make sure that there are at least two people other than yourself who know all aspects of the business.
If you’re looking to get the best out of a sale, make sure that no one person is the focal point of sales, financing, licensing, or customer relationships.
8. Recession resilience
Another factor that potential buyers want to see in your business is recession resiliency – how well can you expect your business to perform during tough economic times.
Many home services businesses can be considered recession resilient, depending on the specific type of work and who your customers are.
Let’s say you have an HVAC business and the majority of your business comes from new homes construction, you’re probably not particularly protected.
You could improve this factor by moving into residential service or refrigeration to help insulate yourself from the impact of a recession.
9. Asset value
What is the ratio between the fair market value of your assets – including trucks, equipment, inventory, etc – compared to the purchase price?
The higher the ratio is, the more attractive your business will look to buyers because if sales absolutely tank after your exit they can always sell your assets.
10. Operations sophistication
This is all about how much your business uses technology and how effectively you make decisions and set goals based on the data at your disposal.
This can include using scheduling, payroll and billing software. Do you have an inventory system that is managed and up to date?
A company that will sell for a higher multiple will also have formalized, written standard operating procedures (SOPs) for all key tasks as well as specific job descriptions.
You should also have employees who are aware of the metrics that pertain to their job and how well they are performing.
Preparing for an exit from your business is something that will ultimately take time. You should start putting in the work now so that you can get the maximum value.
“You need to be honest with yourself about where you are today.,” says Hayden. “And whether it makes sense for you to sell today, or whether it makes sense for you to work on these things and sell later.”
Getting a management team in place, improving company culture, avoiding key customer concentration and increasing sophistication will all help to increase the multiple that your business will ultimately sell for – which could mean a bigger payout to you.
- Potential buyers want an easy transition and will pay for the privilege
- Getting a leadership team in place will let you focus on an exit plan
- Buyers want to see a strong company culture and favorable demographics
- Maximizing for your exit can take months if not years to complete