What Factors Increase the Value of a Business?

What Factors Increase the Value of a Business?

Posted on September 16, 2017

Placing a value on a business is one of the first steps that we complete at Indiana Equity Brokers. Establishing an accurate market value is paramount to a successful transaction.  The actual valuation can be a complicated and intricate process. However, there is a relatively tight pricing, range that most small and mid-sized business fall into. 

Excluding cash, accounts receivables, all debt, and an adjustment for owner compensation; most businesses will be in the 2.0 to 3.5 times seller discretionary earnings.  If you hear of businesses selling for 6 to 8 times, the business is either larger than what we’re talking about here or there were some very unusual circumstances surrounding that business.

However, there are real-world factors that some business have that allow them to sell for a premium.  Here are the main factors that can lead to a business pulling in an extraordinary price at sale:

Financial Performance - A business puts itself in a position to gain a premium price by being a top performer in its industry. The business must have solid revenue and profits compared to similar companies.  Keep an eye on gross margins are they are both a trigger for growth and a safeguard against slow periods.

Trend - Performance should be improving. Sales and profits should have grown in the past 3 to 5 years and have the prospect of continuing to grow.

Market Opportunity - There is a perception that good things are in store for your industry.

Scarce Commodity - You have some advantage such as technology, process, market share, etc. that is expensive to duplicate or compete against.

Customer and Supplier Diversity - Don’t put all your eggs in one basket.  If you have a customer accounting for more than 20% of your revenue, that’s a red flag.  If you only have one supplier for a key product that you sell, that’s a red flag.

Owner Dependent - If you get hit by a bus, what happens to the business?  If the business would keep going as normal (with a little time out to mourn for you), that’s a good thing.  If the business would simply shrivel and die, that’s a red flag.

If you ticked off all the boxes above, you have a business that can enjoy premium pricing when sold. Chances are, however, that some of the items have eluded your business and the market value will fall somewhere between 2.0 and 3.5 seller discretionary earnings.