CEO at Exit Advisory Group, a boutique advisory firm that focuses on mergers & acquisitions, exit strategies, and business valuations.
If you had to condense your business’s complexity into a single, impactful number that truly reflects the performance of your business at any point in time, how would you measure it?
When talking to business owners, I see a clear trend emerging. Many of us are realizing that our businesses might not be as healthy as we thought. From my perspective, the reason is quite simple: You are looking for answers in the wrong places.
The one number you should be looking at amid the jumble of revenue, profits and other traditional metrics is your business valuation, whether you’re planning to sell your business or not.
Why Your Business’s Valuation Number Matters
Consider this: Why are share prices so often published? They reflect what it costs to buy those wealth-generating assets. And movements in share prices reflect the performance of those companies.
Now, measuring business performance is easy to do when you have an open-listed market where share prices are visible and easily accessible. However, these principles still apply to private companies. You might not have a share market where the value of your company is listed, but understanding what drives and determines value can help you build a more successful company in the long run.
A business valuation is one important number you get from analyzing a mix of data and insights. It offers a truly comprehensive view of your business’s health. It goes beyond traditional revenue and profit markers and offers a smarter way of looking at your risks and opportunities.
A business valuation reflects your business’s true state; it reveals strengths and vulnerabilities. With this insight, you can make better decisions, channel resources wisely and make better predictions for your business. This isn’t just a snapshot; it’s your North Star.
Think of valuations as an all-encompassing health checkup. They spot changes in your business’s direction early, allowing timely course corrections. It’s like an early warning system and can highlight the most valuable area to focus your energy and resources.
Measuring Your Business Valuation The Right Way
Now, how do you measure a business valuation? And how do you know your number is reliable? In my experience, most business owners think that if they multiply their profit or earnings before interest, taxes, depreciation and amortization (known as “EBITDA”) by some industry “rule of thumb,” they’ll have their answer.
The reality is far less straightforward.
A rule of thumb suggests that all businesses in one industry are the same, which we know isn’t true. In fact, businesses within an industry can vary greatly. If you’re seeking honest, reliable numbers, you’ll have to dig deeper. You need to understand the qualitative elements that are driving your business. What differentiates you in the market? What makes you a better performer than others?
Consider two companies I’ve personally worked with in recent months: They both provide services for government and blue-chipped clients. And despite nearly identical revenues of around $1.5 million and net profits of $250,000, their exit valuations were worlds apart. The difference? One relied on traditional project-based revenue, while the other embraced the software-as-a-service approach.
How different were their exit numbers? The project-based model sold for three times EBITDA, while the SaaS model sold for a striking 28 times EBITDA. But why the massive gap? How did these two businesses that offered similar services to the same market have such an enormous exit price difference?
The answer is straightforward: It boils down to the unique opportunities and risks each model carries.
Under the SaaS model, the business was benefiting from recurring revenue. The result was reliable, consistent income that predicts a future stream of revenue. The SaaS model also offered maximum scalability. If there are more customers, the business could adapt swiftly. These are all qualitative advantages that the other business could not compete with.
Going Beyond The Numbers: The Qualitative Edge
When you understand how to measure your business qualitatively, you are unlocking a new way of thinking about your business. It’s all about identifying the risks and opportunities within your business.
Let’s start with some of the most common risks that I see:
• Key person risk: Are you overly dependent on key employees—including you? If this person left, how would this impact your business?
• Customer dependency: How much does your largest customer contribute to your overall revenue? If it surpasses 10% or 15%, it warrants a closer look. More than 20% and alarm bells should ring.
• Supplier reliance: Like customer dependency, relying heavily on one supplier disrupts your supply chain. Diversification is pivotal.
• Owner independence: A mature business thrives even without its owner. Could yours endure a three-month absence?
Transitioning to key growth factors:
• Product-market fit: How big is the problem you’re solving, and how well does it resonate with the market you are selling to?
• Market Readiness: How well-positioned are you to capture that opportunity? If your sales volume multiplied fivefold overnight, would you have the right people, systems and processes in place to meet this demand surge?
While the quantitative aspect focuses on the amount of profit you have, the qualitative side focuses on the quality of that profit. Maximizing the quality of your earnings can make the difference between living the life you’ve envisioned as a business owner versus always feeling stuck, frustrated and overwhelmed. You can shift from a situation where your business is running you to you, finally, having control over your business.
And by getting the right balance between your quantitative and qualitative analysis, you can drive a much stronger multiple and valuation of your business compared to your industry peers.
So, if you don’t do this already, I highly recommend you evaluate your business periodically. Your company’s valuation number will guide you to optimize different areas within your organization, determine growth opportunities on a micro and macro level and achieve the legacy you’ve always dreamed of.
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