Selling your business may be the last thing on your mind right now but it’s always a good idea to think about potential value as you build and grow.
In fact, it’s well worth thinking about your business as a saleable commodity on a daily basis; this mind-set will help you make the right decisions along the way which will, in turn, lead to a healthier sales price when you finally decide to exit.
As a business owner, the everyday choices you make about new product lines, strategies and customers are affected by the considerations of risk, capacity and cost. These seemingly small decisions can have a big impact on the eventual value of your business.
Years before you go to sell your business, you are making decisions daily on new product lines, strategies, or new customers. There are many factors you consider to make such decisions including risk, capacity, opportunity costs, etc. One question you might ask yourself is the effect that decision will have on your business some day.
Revenue or profit?
A critical trade off with many product lines, customers, or strategies is the age old revenue vs. margin argument. Is it better to start a product line that will increase revenue, but have a detrimental effect on your profit margin? Or is it better to take on a large customer, even though they demand a steep discount on your products?
When it comes to the value of your company, the answer is clear: revenue wins. The effect of higher gross sales will have a greater effect as you go to sell your business, versus the detrimental effect on the value of your business which will come from a lower margin percentage.
This is backed up by a report from Pratt's Stats. In it they broke down completed business sales submitted by business brokers by three revenue categories.
The categories were businesses for sale with revenue less than $1 million, $1 million to $5 million, and less than $5 million. The multiple of selling price to EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) went from 3.81 (less than $1 million category) to 6.99 (less than $5 million category), and the multiple of selling price to revenue went from .50 to .55. Yet the profit margins of these firms went from 12% to 5%.
For example, if your company has annual revenue of $2.5 million, and you have the average net profit of companies in that range of 8%, your company is worth on average $960,000. Let's say you have a product that will help you maintain your profit margin, and increase revenue by $1 million.
Your company is now worth $1,344,000. But, let's say you went with a product that netted only 4% margins, but had an additional $2.5 million in revenue, making your businesses average margin 6%. Your business would be worth $2,097,000! That is a significant difference.
The moral of the story? Go with revenue over margin to get a better value for your business.
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