Best Practices: Understanding and Increasing Your Business Value
Whether you’re thinking of selling your business, franchising, or you want to secure a future for your loved ones, you need to know your business’ value.
If you don’t, you could be leaving money on the table when a buyer approaches, or setting yourself up for years of hard work long after you planned to retire.
In this article, we’re going to cover all things business valuation:
Why you need to know your business value
“Not knowing your business’ worth is like taking the biggest asset you have and saying ‘let’s just sell it off and see what we get!’” says Shabir Ladha, CPA. Sounds a bit irresponsible, to say the least.
“You wouldn’t leave your house with the grass uncut, shingles falling off, paint not done, and ‘see what you get’ for it. You’d clean it up, get it professionally appraised, and then market it so that it’s worth the most possible when you do sell.”
Why wouldn’t you do that for your business as well?
Selling your business isn’t the only reason to get a business valuation, either. In fact, waiting until you’re ready to sell is a pretty bad idea.
You could find out that the business is worth less than you thought, and that it will take a few more years to reach your desired price. For some, those extra years might not be possible, which means they’d be forced to sell for less than they wanted.
What are the reasons to get a business valuation?
- Preparing to sell
- Bringing on a partner
- Succession or retirement planning
- Taking out a loan
- Franchising
- Personal matters (i.e. a divorce or death)
- For your own knowledge
“Beyond preparing to sell, there are many reasons you want to know your business’ worth,” says Shabir. “For some people, it’s ego. You’ve put a lot of time, work, and effort into this business. You should know whether you’ve built up value.”
There are also unexpected personal issues that could come up. For example, you or another business owner passes away, you may need to pay an estate tax. It’s better to know your business’ worth ahead of time so that the burden doesn’t fall to your loved ones.
Succession planning is another major reason you need to know your business value sooner rather than later.
What is succession planning?
Succession planning is the process for determining who will take over your business when the business owner leaves or retires. Succession planning involves training new leaders and developing systems and processes that can ensure the business’ continued success. The process can take several years and is often done with the goal of minimizing disruption or financial loss to the business.
“70% of business owners over the age of 60 don’t have a succession plan,” says Shabir. “Most haven’t thought about it, or they’ve thought about it loosely but they don’t have a plan. They think ‘my kids will be old enough, I’ll sell it to them. That’s not a plan, that’s an idea.”
A real succession plan—the kind that will help ensure a financially successful future for your business—involves sitting down with your accountant to figure out what your business is worth today, and what you need to do to increase the value by the time you’re ready to leave.
How to calculate your business value
So now you know why you should valuate your business. How do you actually do it
Shabir shares two common accounting methods:
1. Liquidation value
The first method is relatively simple: “basically, you take your assets, deduct liabilities, and what’s left is your business’ worth,” says Shabir.
For example, if you own a lawn care business, you’d collect all of your accounts receivable (aka sent invoices) and sell off all of your equipment for cash. Next, you’d pay off any debt you have. The amount left in your bank account is your business’ value.
This process works well for product or equipment-based businesses, but not so much for service-based businesses. Intangible assets, such as your brand or customer list, aren’t calculated, so you’re likely leaving lots of money on the table.
2. The EBITDA method
EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization, is a much more detailed method for calculating your company’s overall financial performance and profitability.
To calculate EBITDA, you add your net income, interest, taxes, depreciation and amortization. You then multiply the total number by a multiple. “The multiple changes based on intangibles, such as your industry, your brand, the types of contracts you have,” says Shabir. “It’s much more of an art than a science.”
While you can calculate this on your own, to get an accurate assessment, you should pay a visit to your accountant or a CBV (certified business valuator). They’ll generate a highly detailed, professional report that explains your business’ background and what methodologies were used.
READ MORE: 30 small business tax deductions to save money when filing
How to increase your business value
Now for the million dollar question: now that you know your business value, how can you increase it so that it’s worth the most possible?
The first step is to talk to your accountant. “Your accountant should have a good understanding of your business, and be able to give you tips on what to change so that your business becomes more valuable,” says Shabir.
A few questions to ask your accountant to get started include:
- What parts of my business are negatively affecting its value?
- What parts are positive affecting it?
- What can I do differently to increase my business’ value?
- How long will these changes take to have an effect?
The second step is to understand the factors that can affect your business valuation.
What factors can affect your business valuation?
- Your customer list
- Your brand and reputation
- Your location
- Your website
- Long term contracts
- Patents, copywrite, or intellectual property
- Systems and processes
Unlike accounts receivable or equipment, which can be liquidated into cash, these factors are often ‘intangible.’ That doesn’t make them any less valuable.
Your customer list and brand are two of the most common and valuable business assets. But don’t stop there. A great URL and high-traffic website can bring in considerable cash.
Then, there’s process. “Process in itself can create value,” says Shabir.
Take, for example, a McDonald’s franchise: “I don’t want to sit down and figure out how I should make the hamburger, or which fryer to buy. When I buy the franchise, I have everything pre-established. All of the processes and procedures are in place. That’s why at one point it was $1 million to buy a McDonald’s franchise, plus a fairly hefty royalty fee. It’s worth it because of everything McDonald’s has put into systematizing the business to begin with.”
The same goes for selling your service business.
“Imagine two businesses,” explains Shabir. “One uses Jobber to manage its workflow, track staff, and collect all of its receivables. The other uses an old paper system to hand-write invoices and has to wait to collect cheques. The one using Jobber is going to be more streamlined and efficient. It will collect money faster, lower bad debts, have less administrative staff because the app handles so much.”
“When you layer it together, that process creates more profit, which creates more value.”
Poor processes limit who can buy the business. If they don’t have a solid handle on your industry or how to clean up an administrative mess, they’ll think twice about buying.
Last Words on Business Valuation
Your business’ worth is much more than what’s in your bank account.
The real value of your business comes from everything you do to make it more profitable, more established, and more streamlined.
Strengthening your brand, growing your customer list, and implementing systems and processes are all ways to increase your business’ value, whether you’re thinking of selling soon, or building an empire to last for the ages.
Thanks to Shabir and KBH Chartered Accountants for the invaluable advice!