Key takeaways for “One Simple Tweak That Can Add Millions To The Value Of Your Business”:
- The equation to determine the value of your business
- Definition of business multiple
- Guidelines of the multiplier
- 3 examples of how to increase your multiplier
Most entrepreneurs understand the role (and importance) of profits when it comes to determining the value of your business.
They’ll go thru great lengths to add to their profits in an attempt to add value. In many cases, they’ll make short-term decisions that may add profits but ultimately lower the value of their company.
How is this possible?
The Equation To Value Your Business
Again, many entrepreneurs will focus solely on profits. These types of business owners are more hands-on and perform many of the top-level tasks themselves. They make all the decisions and control all the finances because, in the short-term, it lowers expenses (thus adding to profits).
However, the profit is only 1 part of the equation used to determine the value…
And it’s not even the part of the equation that will have the biggest impact on your overall value!
Here is the formula I would use to conceptualize the value of your business.
Profit × Multiple = Value
The magic number is the ‘Multiple’ number.
What Is Business Multiple?
Valuation multiples are calculated based on the assessment of a set of financial and operational factors. These multiples will vary depending on many factors including earnings history, the sustainability of your business, the industry you’re in, and more. There’s no set ‘one size fits all’ multiplier.
But to simplify, I’ll use the following examples based on smaller business ($250k – $2 million of yearly revenue with minor projected growth) in order to show how the multiple can impact the value of your business:
- An extremely well-established and steady business with a rock-solid market position, whose continued earnings will not be dependent upon a strong management team: a multiple of 8 to 10 times current profits.
- An established business with a good market position, with some competitive pressures and some swings in earnings, requiring continual management attention: a multiple of five to seven times current profits.
- An established business with no significant competitive advantages, stiff competition, few hard assets, and heavy dependency upon management’s skills for success: a multiple of two to four times current profits.
- A small, personal service business where the new owner will be the only, or one of the only, professional service providers: a multiple of one times current profits.
Going back to the value equation: Value = profits x multiplier. If you have a small business that does $1,000,000 of revenue and a multiplier of 1.5, then the value is $1,500,000. This may be the type of business being run in guideline 4.
Now, imagine if you had a business with established systems and processes in place. It may not be as profitable, but because you have people in place who handle sales, operation, and finances (the owner is not the ‘king’ of the business), the multiplier may be 2.5.
That would give the value of the business $2,500,000.
The impact of the business multiplier on the overall value of your business is much bigger than profits. In fact, it’s much easier to double or triple your multiplier than double or triple your profits.
Hence the irony of running a business based solely on profits: you’re working very hard to devalue your company’s value!
How Can I Improve The Multiple Of My Business?
The best ways to improve your multiplier involves creating systems and processes, focusing on specific market niches, and adding consistent revenue & growth. Below are three examples of how you can add value to your business by improving your multiplier:
- Creating systems and processes: Taking you as the business owner out of the day to day activities will impact your multiplier. Let’s take a simple example to illustrate: Imagine you run a company with $2 million in revenue and you pay yourself a salary of $200,000 a year. Further, let’s assume you could get a competent manager to run your business as a division of an acquirer for $100,000 per year. You could safely make the case to an acquirer that under their ownership, your business would generate an extra $100,000 in profit. If this simple move allows them to pay you three times profit for your business, that one adjustment has the potential to earn you an extra $200,000.
- Focus on specific market niches: The average small business will not dominate an entire industry. If you’re a digital marketing agency and you cater to ‘small businesses’, you don’t have a niche. If instead, you focus on helping real estate investors generate leads using Google and Facebook, then you have a specific niche. With this focus, you create systems for client onboarding, campaign set up, copy & image assets and more. Finding your niche and dominating it allows you to become the expert and create much more value.
- Adding consistent revenue & growth: One of the hottest trends in business right now is finding transactional services and turning them into SaaS (subscription as a software) services. The best example is the Dollar Shave Club. They took a homogenous product that people would buy when needed and turned it into a subscription service. By adding convenience and eliminating the “pain of paying” aspect, they are able to create a consistent growth and revenue stream. Another example is The TelMed Network, which replaces the transactional utilization of using telemedicine on-demand with a lower-priced monthly subscription service.
Summary of One Tweak That Can Add Millions To The Value of Your Business
While focusing on profits for the long-term is smart, a big mistake many entrepreneurs make is focusing on short-term profits at the expense of overall value. Many of the short-term business decisions used erroneously to make the business appear more profitable ironically make it less valuable. Instead of just focusing on profits, think about how you can increase your business valuation multiple. Tripling your multiple can be quicker and much easier than tripling your profits.
If you have any questions about how to add to the value of your business, feel free to contact us.