You’ve worked hard over the years to build your company, and now you’re thinking about selling all or part of your business. But rather than immediately focusing on the “who,” “what,” “where,” and “when” aspects of sales and valuation, as many executives do, consider this question: Are you sure that your business will be fully valued, or will even be attractive to a prospective buyer or investor? These questions and more should be included in the steps to selling your business.

The fact is that very often, businesses are undervalued because executives overlook or underestimate the importance of six critical factors buyers use to make their decisions. Moreover, it is not enough to know where to sell your small business, you must also know how to sell your small business. Take a step back and examine some of these things you may have previously regarded as unimportant. The good news is that, by addressing these issues well before you put your business up for sale, you can significantly increase margins and growth and maximize the value of your business in the marketplace.

Are You Leaving Money on the Table?

Buyers actively seek to buy underperforming businesses where a combination of operating improvements and growth can result in high returns. You must have a firm understanding of what is capital in a business. Take the fictional example of a large private equity fund that purchased a rapidly growing technology firm. The revenues declined under the former owners from approximately $40 million to less than $20 million. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) declined from over $10 million to less than $5 million.  

The buyer brought in new management and made numerous operational and financial changes to increase EBITDA to $10 million within a year of buying the company. The new management team took steps to save on manufacturing costs. A new sales team was able to increase sales and reduce working capital.

This story gets repeated numerous times across every industry as buyers, such as private equity funds, announce successful exits from investments. The question for you as CEO or senior executive is, “Will you make the operational improvements and have your company fully valued, or will those gains accrue to the buyer because they made the operational improvements?”   

To increase the value of your business, think like a prospective buyer or investor. Use the following questions to help you determine where to focus your efforts:

1. Do you have a clear vision and mission for your company and can you communicate it to your buyer?

A well-defined statement of vision and mission sets the context for all of your business decisions including advanced business capital advice. However, buyers will be looking to see if these statements are supported with up-to-date systems and processes. This includes a strategic business plan, annual budgeting process, accurate financial statements, and specific metrics for operating the business. Many times, pieces of this information can be out-of-date or missing, especially when a company is in high growth mode. Even worse, some companies do not have the systems capability to allocate inventory costs to sales and instead expense the inventory when purchased. The inability to maintain accurate records can cost your company dearly in creditability and valuation. Keeping this data current in an easy-to-access format generates confidence in your company’s ability to achieve its vision and mission and allows the buyer to give your team the benefit of the doubt for those “off” years where earnings and sales were down. 

2. Is your business growing at a rate commensurate with or above the rate of growth for similar-sized businesses in your industry?

If your industry is growing, but your business is not increasing at or above the growth rate of the industry, you need to look at changing your customer base or changing the way you sell your products.  The growth rate of your business is critical because it demonstrates the acceptance of the product by the customer base. If the growth is below the industry average, a problem exists somewhere in the business. High growth businesses command a higher multiple of EBITDA than lower growth businesses. A buyer is looking to double or triple the investment in five years and needs to be convinced high growth is possible, or the investment will not be successful for them. Looking at why your business is not growing at or above the industry norm and making the appropriate changes could have a significant impact on your business’s valuation.

3. Is your business operating at or above the gross margins for similar-sized businesses in your industry? 

If your gross margins are below the industry norm, you need to reduce your materials costs or lower labor and other direct costs.  These costs are the cost of goods sold that are typically 100% variable. Margins reflect how well you manage the production process. Low margins imply a commodity business with little competitive advantage other than price. Higher margins command large premiums since they imply a defensible market position. Gross margins are often related to how successfully the business is at buying materials that go into the production of the final product as well as how controlled are the direct labor costs.  

4. Do you focus on maximizing cash flow or minimizing taxes?

The best approach is to maximize cash and not to manage the business to minimize taxes.  When cash is the focus, there is typically more money flowing into the owner’s pocket.  One of the most important components of valuation is the cash flow or EBITDA. Anemic cash flow due to management’s focus on maximizing tax savings and not on generating cash can significantly reduce the valuation of the business. Your business’s ability to generate cash will be buyers’ prime criteria for valuation. Additionally, a business with a small capital structure might not look as appealing to some buyers. If you have not focused on the cash you may find your business valuation significantly reduced due to a poor cash generation history.  

5. Do you have an undue concentration of revenue with a single large customer? 

We would recommend that a balance be achieved of no more than 10-15% of sales from any single customer with the balance of sales being broadly diversified among numerous smaller and mid-sized customers. Your customers should also be spread among more than one industry. A large customer, one that creates over 30% of your revenue, can put your company at risk if the customer goes out of business or decides to replace your company with another supplier. This can reduce the valuation because the buyer will want to mitigate this risk by paying a lower price. Therefore, while the sales cycle may be faster by concentrating on selling to a few large customers, creating a balanced portfolio of revenue is an essential strategy if you’re interested in gaining maximum value for your company. Increase business value and seek business capital elsewhere.   

6. Is your organization optimally led and managed?

One of the most important criteria for a buyer is a competent, high-performance executive team. While documented processes are one measure of control, it’s important to look for multiple pieces of evidence that the rest of your organization is operating at maximum speed and effectiveness. Persistent organizational problems, such as unusually high employee turnover, absenteeism, hiring difficulties, resistance to new technology, and a high number of customer complaints, can often be signs of overlooked leadership and management issues. The greater the degree to which formal processes are in line with these measures of organizational reality, the greater the buyer’s confidence will be in your executive team and in the organization’s ability to deliver what it promises. 

Higher Value for Your Future

If your company comes up short in one or more of these areas, it may be tempting to leave these issues for the next owner to fix. However, as we demonstrated in the technology company example, this can result in leaving money on the table. Plus, by addressing these issues early and taking care of them as they arise, not only will you get the larger payoff at the end, but you will also benefit along the way because you will improve your company and be able to enjoy its success. 

When you address these six questions on a consistent basis, long before putting your company up for sale, you’ll be rewarded with a maximum return on your business, higher equity valuation, and an accelerated sales process. You’ll discover where to focus your efforts on a consistent basis, as well as the necessary steps to take to ensure you have a well–run business, and your results will enable you to get the highest value for your business, regardless of the current economy.