What is your business actually worth? How do we increase business value?
We all know the easy answer to the first one……whatever someone is willing to pay.
It’s true, but not massively helpful when planning the strategic direction of a company. Or, how you may sell it one day for a large sum of money.
To value a business the formula is generally simple:
Value = Profit (ebitda) x Multiple
In other words, when someone buys your business, they are paying you a number of years of profit in advance. The multiple being the key.
When most of us think of ‘growth’ and increasing value we think about making more profit (improving the cash-flow). If we make more profit, the business is worth more. It’s simple, easy to say and not necessarily a bad strategy.
The problem is that for most, growing profitability isn’t as easy as clicking your fingers.
You may have realised now that you can also increase the value by making the multiple a bigger number.
The majority of company owners know how to increase their profitability, it is their business and life’s work after all. However, not as many know how to increase the multiple.
Increasing the multiple is a huge topic; there is an entire industry built around it. Unfortunately, therefore I won’t be able to demystify the whole topic in one blog post. Hopefully though I’ll be able to provide some examples of just how vital it can be.
The picture below gives a snapshot of one of the valuation frameworks I use. You’ll see the benchmark line; which is what the average multiple is for a particular industry at a particular time.
In most industries the benchmark average multiple will probably be around ‘5’. If you’re in Silicon Valley running a tech outfit it could be much higher.
For the sake of simplicity; let’s assume your industry benchmark multiple is 5 and your profitability (EBITDA) is £1m. Your business at benchmark is therefore worth approximately £5m.
Now, say you have invested wisely in building a strong culture system in your business; making it a place where the best talent in the sector wants to come and work and stay working. Depending on what your business is, I’m sure you can quickly come up with a few ideas that would help make this a reality. If achieved, it’d turn your multiple from 5…to roughly 6.2; putting £1.2Mil on the value of your business.
For the majority of businesses, it is much easier, quicker and less expensive to improve the culture than say, finding another £200,000 of annual profit from new market share. And they both have the same net effect on the value of the company.
Summarising… your business is worth what someone is willing to pay. They’ll pay more for a business that has a greater future profitability. Future profitability isn’t necessarily affected by how much money you’re making now, but more about the assets in your business that will continue to make money (like a strong culture) in the future.
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