Preparing to Sell Your Business – 5 Years Out

Key Takeaway: Many business owners wait until they are ready to sell their business to find out that they could have received a higher offer had they worked on some issues a few years in advance. Thinking about those issues three to five years before a sale can help you get a price that allows for a more comfortable retirement/next phase.

The increase in interest rates has changed the math for businesses wanting to sell. This higher cost of doing business is because buyers will often take out debt to finance the purchase. Today that debt costs them more with higher interest rates, so they are now willing to pay less to the seller. Thus, if you are a seller of a business, it is more important than ever to start thinking three to five years ahead of time about the changes you should make to your business that will allow you to sell for the number you need to create a comfortable retirement for you and your family. There are three issues to consider addressing: margin analysis, operational efficiency, and technology integration.

Step 1: Perform a Margin Analysis

Many entrepreneurs build their businesses over decades of taking any revenue they can get. If the top line is growing, they are making money. But when you bring in a buyer for your business, they look at the business in a different light. Most buyers want to pay you a multiple of net income (sometimes referred to as EBITDA, or earnings before interest, taxes, depreciation, and amortization). And when they look at net income, they look at the quality of that net income.

For example, suppose you have two businesses (A and B). Business A has $6 million in revenues, and Business B has $9 million in revenues. Business A has 30% margins on that revenue, and Business B has 18% margins on its revenue. Thus, Business A has net income of $1,800,000 (30% of $6 million), and Business B has net income of $1,620,000 (18% of $9 million). Business A has only two-thirds of the revenue of Business B, but it is worth more because it has better margins. If Business B could increase their margins by 2%, up to 20%, they would now equal Business A.

But does that mean Business B is equal in value? Maybe not. A buyer might look at the revenue and think that Business A is just running better because they have better margins on lower income. Thus, someone might offer them a premium for that. It makes sense: Business A might have less work to do (fewer clients) while making more money.

Understanding how to increase your margins is a whole different blog. It might be through automation/technology that could lower your need for people. It might be through exiting some lines of business and focusing on the most profitable lines. It might be through new product ideas that move the company in a whole new direction. Before you know what to do, though, you need to start with a margin analysis to understand what can drive the value of your business over the next few years.

Step 2: Assess Operational Efficiency

Many entrepreneurs are the visionary of their organization and, often, good salespeople. They have had to be to grow a business. Yet they might be weak in operational efficiency. By nature, they might not be process-focused, detail-oriented, enjoy training people, focused on day-to-day accounting, and doing all the small things to correct the cracks that inevitably appear in all businesses. But operations can add a lot of value to your company in a sale.

Someone buying your company does not want to have to step in and fix things. They want to know that the company will run itself and that they just need to do a few bigger things to make even more money. This is why buyers look for companies that are operationally better. They know that a company operating well will have higher profit margins. A buyer is willing to pay more for that.

The opportunity with operations lies in creating process/workflows to make the routine tasks that support revenues more efficient. When I say more efficient, I mean that a business can do more, with fewer people, making better margins and providing better customer service. That flywheel, once it gets going, makes the company more money as customers buy more or refer their friends, family, and fellow business owners.

I will go out on a limb and say that I believe most companies do not focus on this early enough (such as the first few years of their existence), and they often ignore it going into a sale of the company. And that hurts the price they get. When I talk to larger buyers of businesses, they talk about how operational efficiency is worth more because the businesses do not need as much handholding. Being operationally exceptional is a mindset that I believe needs to be adopted to maximize the value of a business.

Step 3: Integrate Technology

Whenever talking about operational efficiency, technology is a word that comes up. I am adding another word: integration. Technology on its own is useful at a surface level, but it is effective only when you dig deep into integrating all its capabilities. For example, many business owners think of a CRM (customer relationship management software such as Salesforce) as a repository for telephone numbers, addresses, and some notes. But if you use it to fulfill your processes, you can streamline to the point that all customers have a unique outcome but a common, diligent process.

Now take it a step further. If you streamline your process so that all customers get the same great service, you are also collecting data in the same way. And the more data you collect, the more useful reports become in telling you what is going on in your business.

Taking it a step further, it is becoming clear that AI (artificial intelligence) needs data. So, the more data you can keep, the more AI will become a powerful tool and increase your margins.

Technology then becomes a measuring stick for business valuation. Buyers want to see that you use technology to answer operational efficiency questions, have deep and broad integration (connecting to other technologies to share data/process), and have an ongoing focus on improving technology. Buyers will pay more typically for businesses that run on technology than those that need a lot of people.

Step 4: The Sale

Margin analysis, operational efficiency, and technology integration are not the only issues to work on before a sale. But I believe they are foundational to increasing the value a business owner can get from a sale. And I would add, give yourself time to work on them (three to five years). That way, you can capture the momentum from them that will show a buyer that you have built a quality business that they should pay a premium for. You will also feel better about the sale process since you can go out on a high, knowing you did all you could to give your family more resources for the next phase of life.

The opinion of the author is subject to change without notice and must be considered in conjunction with relevant regulation, as well as subsequent changes in the marketplace. Any information from outside resources has been deemed to be reliable but has not necessarily been verified. Each individual has unique circumstances to which this information may or may not be relevant. Under no circumstances will this information constitute an offer to buy or sell and it does not indicate strategy suitability for any particular investor.