A Snap Lesson in Business Valuation
I’m focused on driving faster profitable growth, getting leaders more money from business and more time for life. I’ve talked with a number of people that are brokers for business sales and others that are more merger and acquisition specialists. We all find it amazing that business owners often don’t understand what will create value for their businesses. They have spent years milking the business, taking out as much money as possible while minimizing the taxes owed to governments. They spent the early part of their business working their buns off to build the business. Rightfully, they feel they deserve to sit back and enjoy the benefits of all that hard work.
Unfortunately, they are missing out on some significant money when they exit. Buyers and brokers can easily explain the difference between seller’s discretionary cash flow and EBIDTA. Sometimes it takes a bit of work to understand all the different ways that owners are benefitting financially from their business. Some are unwilling to help the broker understand all the ways. That can significantly reduce the value of the company and the amount the buyer will pay. With purchase prices for small companies ranging from 2x to 7x seller discretionary cash, ten thousand dollars in hidden financial benefit for the customer can cost seventy thousand dollars in income. That could be enough to pay for the broker fee.
Another factor that is disturbing is the hand-waving that goes into the business offer documents. Often the broker works with the seller to position the business as a great opportunity for growth. I’ve seen offerings talk about how the new owner has tremendous opportunity to grow the business by updating technology on the website to improve SEO, going after related markets, or generally improving the business. Sometimes the offering documents suggest the current business owner has just been too happy with the existing business and not willing to work to grow it. But, the new owner has unlimited, untapped potential for the business to grow. the broker and seller are trying to position the company to fetch, say, 4X instead of 2.5X. I don’t think buyers are willing to pay so very much for untapped potential. I think they need some evidence of the potential.
That’s where my reference to Snap and SnapChats IPO this week comes to play. Consider these charts. While Snap is not making money, its revenue is growing and its engagement with a key customer segment is growing. The documents provided to investors show how this company is not just poised for growth, but what they are doing and plan to do to achieve faster profitable growth. Investors have been impressed enough with the story that the stock was priced above the initial target and bumped up 44% in the first day. You may not believe the story, but a number of investors familiar with this space do.
What story are you telling a prospective buyer of your business? If you are just hanging on and taking money out of the business, then don’t be surprised if a buyer does not want to give you 6X. For a small company with $500K in seller discretionary cash flow, the difference between fetching 2x and 6x is $2 million. That’s often the difference between retiring in comfort versus having to work 4 more years. If you had $200,000 to invest to show a difference between 2X and 6X, you could achieve a 10 to 1 payback on your investment in just 1-2 years.
If you want faster profitable growth from your business; if you want more money from the business; if you want more time for your life, consider taking action to improve your business now, before you get a broker involved.