Do you know the value
of your business?
Most business owners have a figure in their head to answer the question “how much is my company worth?”
However, the number they are thinking of doesn’t always represent the actual value of their company.
How to Determine Your Company’s Value
Adjusted EBITDA × Valuation Factor (Multiple) = Business Value
At first glance, this might seem like a simple question that can be solved with a quick calculation.
However, things are not always as simple as plugging numbers into a calculator. Both factors in this equation require proper setup to be sure they are calculated correctly. If done wrong, you will not be able to determine the true value of your company, running the risk of minimizing your return in a sale or not being able to transition away at all.
EBITDA
Less than 10% of companies we see have a properly calculated EBITDA when we begin working with them.
Complexities of Calculating EBIDTA
The first step towards determining the true value of your company is having a properly calculated EBITDA.
There are many complexities when it comes to calculating EBITDA. An owner first needs to understand if the books are being kept properly and review their chart of accounts to ensure it is properly set up.
Typically, a chart of accounts is set up incorrectly in companies that are either very small or in very early stages. In these types of companies, there is often no controller on board and no professional bookkeeper.
While these companies are most likely working with an accountant to file their taxes, they are often not working with accountants who have the experience to ask the correct questions. These questions could include a deep dive into the amount of product or services you need to sell to break even, which starts with a correctly calculated gross profit margin.
If the chart of accounts is properly set up, the coding will also need to be reviewed to ensure it makes sense.
Some examples of where coding in a chart of accounts may not make sense would be:
● Project based work – if your work is project based, but no costs are allocated to projects and everything is being booked as administrative, you are unable determine true gross profit margin
● Manufacturing based work – if all salaries are being booked to general and administrative instead of cost of goods sold, you are unable to calculate a gross profit margin correctly
Why It's Important
Calculating a true and correct EBITDA relies on accounting functions and cost allocations being handled correctly – without this, it is extremely difficult to determine the true value of the company.
The Multiple or Valuation Factor
It is impossible for the business owner to control the multiple or the valuation factor of their own company because they cannot control market conditions and other outside factors.
Role of Market Conditions
The next factor in the equation to determine your company’s worth is the valuation factor or multiple. This factor is determined by market action – actual sales, actual buyers, and actual sellers in the marketplace.
We like to use the analogy of selling a home. The seller can’t control the prices of homes in a desirable neighborhood; they also can’t control if the price should be lower or higher because that’s determined by the market supply and demand.
The same thought process applies to businesses – the range is determined by the market, not the owner.
What You Can Control: The Curb Appeal
With a home, the only thing the seller can control is curb appeal and condition of their house. When we apply that thought to a business, we see that the owner can only control how well it presents to the market based on how tightly they run the ship, how profitable the company is, and how organized it is. An owner can increase the “curb appeal” of their company to hopefully influence the valuation factor, but they cannot control the factor itself.
How Does an Exit Planning Consultant Help?
If the only way to influence the valuation factor is to increase the “curb appeal” of the company, you will want to bring in experts to help you “stage” your business to accomplish this. This is where an exit planning consultant will bring their expertise and make sure your business and exit plan is clean, clear, and organized.
Key Factors an Exit Planning Consultant Reviews
- Owner dependence
- Customer concentration
- High cash flow
- Solid sales pipeline
- Strong management team
- SOPs and documented business processes
- Technology stack
- Loyal employee base that produces optimally
Aligning Goals and Financial Planning
Your goals as an owner will also be discussed – ideally, you have talked about this with a financial planner or similar consultant before an exit planning consultant is brought in. However, if this is not the case, this should be discussed during the consultation process.
From there:
- The wealth accumulation and targeted income needed to meet your goals will be determined.
- This will be compared to where you are today, including your business’s current worth.
Closing the Gap
Finally, any gaps between where you are today and where you want to be when you exit or retire will be identified. These gaps become the starting point in the improvement process, which is completed with your exit planning consultant. This process addresses any problems uncovered during the review.
The Goal: Maximizing Your Company’s Value
The goal here is to get the “curb appeal” for your company as high as reasonably possible to ideally influence the valuation factor without having control over it, thus maximizing the value and worth of your company.
If this sounds complicated, it’s because it can be! However, being complicated does not mean it is not worth it – by knowing the true value of your company, you can have a clear plan for moving forward through the years and eventually being able to successfully transition away from your business.
Working with an exit planning consultant alongside your financial team is the best place to start when looking for the true value of your company with the goal of exiting the business.