No One Will Pay You for a Business That Amounts to Working 60 Hours a Week at $16/Hour
Larry Goldstein, Business Broker at First Choice Business Brokers
Why do many businesses fail to sell? Are non-selling businesses flawed in some way? In short, buyers look at financial results. And unfortunately, many small businesses fail to sell due to sellers having unrealistic value expectations and poor financial performance on the company's end.
However, there are several steps a business owner can take in order to avoid falling into the 'non-selling business' category. First, let's examine these two areas where owners want to avoid finding themselves in the first place.
Sellers with Unrealistic Value
Overvaluation of a business is one of the key reasons sales don't go through.
Just as with property prices, it's pretty easy to believe in the hype surrounding valuations and not see the real value of your business.
This is particularly true for business owners who have built their business from scratch—working 80 to 100 hours a week to keep it alive. You may have put your heart and soul into the business, but you can't expect the buyer to do the same.
And it makes sense.
Why would anyone buy a business to work 60 hours a week at $16 an hour?
I asked a business seller the same question after claiming her business should be worth $150,000. She believed that the hard work she had put into the business—working 80 hours a week would be worth something to a potential buyer.
Was it? Let's find out.
Running a business can be hectic. Many small business owners work 18 hours a day, seven days a week. No regrets. No apologies. They put so much effort into pursuing a cause they believe in, even if it means earning a meager salary to keep it running.
However, it's important to understand that hard work doesn't guarantee you've created value for your business or that it will sell someday.
What buyers want is "value," not "what transpired to keep it running."
The truth is, buyers will not always see the "behind the scenes" aspects of your business. What they're willing to pay for your business will come down to the figures on your financial statement and the company's potential for growth.
In our case, the lady assumed her years of sacrifice created value. She ran a business with revenue, expenses, profit, and assets. She had all the parts, but the parts didn't contribute to something worthy of the $150,000 price tag she claimed the business was worth.
What her business lacked were desirable results.
Simply put, you'll need to show results that will attract the buyer. Results that will compel the buyer to take action. Results that will make the buyer see a potential for growth in your business, making them want to buy your company.
The irony is that she wanted to leave her business because the work was strenuous and paid too little—but expected someone else to buy it at an astronomical price.
Two areas matter when it comes to the desirability of results:
- Increase your SDE (Seller's Discretionary Earnings)
- Improve your job
Increase Your Seller's Discretionary Earnings
SDE or Seller's Discretionary Earnings is often used when valuing a small business.
If you haven't heard of SDE, you probably have heard one of its many names. It's also known as Total Owner's Benefit, Adjusted Cash Flow, Recast Earnings, or Seller's Discretionary Cash Flow. But what exactly is Seller's Discretionary Earnings?
SDE is a cash-flow-based measure of a company's earnings in an owner-operated environment. This metric is used to assess the value of a business to provide potential buyers with a clear picture of their expected return on investment.
That said, SDE comprises the profit before taxes, plus:
- Interest expense on long-term debt
- Depreciation and amortization
- Owner's salary
- One-time expenses that will not occur in the future
- Personal expenses related to the owner of the business
From the seller's standpoint, calculating the SDE allows them to maximize the value of a business before getting into a sales negotiation with the buyer.
SDE helps businesses compare other businesses' values and cash flows by "normalizing" their financial statements, so buyers can estimate the expected cash flows more accurately and compare them to others. As a seller, SDE is your best negotiation tool.
The higher the SDE, the better your chances of selling your business at a competitive price. Nothing else comes close to the importance of SDE.
Improve Your Job
As a business owner, improving your business falls on your shoulders.
What will potential buyers say about your business if they learn you work 18 hours a day? Will they be enticed by your business or feel sorry for you?
It can be hard to run a business. If your business is so demanding with strenuous tasks and below-average income, know that no one else will want to do it—let alone pay a hefty price tag for it.
The trick is to improve your job in every way possible.
Learn to work smarter than harder. Implement new technologies that will simplify mundane processes and make your job easier.
If you can leverage technology and reduce the workload, you'll realize that revenue and profits will also increase. And your business will be more attractive to potential buyers owing to the smart technologies and improved revenue, as seen in profitability ratios (see below).
If you have a key employee that you can rely on, consider taking the time to train them on tasks that would normally fall on your shoulders. Promoting an employee that already understands your business can be a huge lever in making your business more appealing to buyers. It can also help ensure your most important employees remain on-board.
Poor Financial Performance
As mentioned, your company's financial performance will also determine whether your business sells and at what price.
If your company isn't performing well financially, buyers will not show interest in purchasing it. Buyers usually show interest in companies that show increasing profit year on year.
When reviewing the financial performance of your business, potential buyers will look at these four financial ratios.
- Gross Margin Ratio
- Liquidity Ratios
- Inventory Turnover Ratio
- Debt to Asset Ratio
If your business sells products, this is the ratio you'll want to pay attention to.
Also known as the gross profit margin ratio, this ratio shows the amount of profit made before deducting general and administrative costs. It represents each dollar of revenue a business makes after deducting COGs (cost of goods sold).
The higher the gross margin, the more money your business retains to pay for other expenses. A low gross margin may signal you're having trouble paying other expenses. Buyers will show interest in a company with a high gross margin ratio.
Liquidity ratios assess a company’s ability to cover debts and meet other financial obligations. The two key liquidity ratios are quick ratio and current ratio.
Quick Ratio
The quick ratio tells whether you have enough current assets to cover current liabilities.
Also known as the acid-test ratio, the quick ratio is ideal for any business with current liabilities such as accounts payable, credit card debt, income taxes payable, and short-term loans. Investors are attracted to companies with a high quick ratio.
Current Ratio
The current ratio shows a company's ability to pay off its short-term obligations, particularly those that fall due within a year. Current ratio is defined as the Current Assets divided by Current Liabilities.
Sometimes known as the working capital ratio, the current ratio shows how well a company maximizes current assets to pay off its short-term obligations. Potential buyers will be attracted to a business with a current ratio between 1.5 and 3.
As the name suggests, the inventory turnover ratio is helpful for businesses that carry inventory. It tells business owners how many times inventory was converted to sales over a given period.
Buyers will particularly be interested in this ratio. It tells them whether the business has non-salable or slow-moving inventory. It's worthless if the company has non-saleable inventory, so you'll want to present a high inventory turnover ratio to the buyer.
The higher the inventory turnover ratio, the better. It tells investors that the company is selling goods quickly, and there's high demand for the products.
This ratio shows how much of a business is owned by creditors instead of investors. You'll want to keep this ratio as low as possible. A high debt-to-assets ratio could be a sign of financial instability.
How to Improve Your Business Valuation
Selling a business presents a big challenge for business owners.
Besides the complexity of the process and the emotions involved, business owners need to maximize business value to receive attractive prices. But how can you increase the value of your business? Here are 5 proven tips to increase the valuation before you sell.
- Diversify Your Revenue
- Aim to Improve Your Cash Flow
- Become an Authority in Your Niche
- Work to Boost Your Profits
- Seek Advice
Sure, buyers want to see growing revenue.
But they are not just looking for gross dollar amounts. Potential buyers will want assurance that the business will continue to perform, even if one product line is cut short.
In other words, they want a business with multiple revenue streams.
That's why diversifying your revenue is critical. The more ways your business brings in money, the better. The trick is to minimize large product or customer concentration. Seek potential new audiences or introduce different types of products.
As mentioned, managing your business cash flow is critical to your company's success.
Improving cash flows will enable you to run your business efficiently and make your business attractive in the eyes of investors.
Buyers will want a business with positive cash flows that have the prospects of increasing in the future. If you have steady cash flows and can document this clearly, you'll have higher chances of securing investors or buyers.
On the flip side, if you're struggling with negative cash flows, your business will put off potential buyers. However, you can always find ways to improve cash flows and strengthen your overall position.
For small businesses, finding and establishing dominance in a niche is critical.
By specializing in a niche, potential buyers will see you as an expert in your line of business. Likewise, customers will trust your brand and even become your brand advocates, spreading positive vibes about your business on social platforms.
Most successful businesses have established a niche and will tailor their business practices to best suit this market.
In contrast, attempting to cater to all niches might position you as a jack of all trades. Always find your unique selling point, capitalize on where your business strengths lie and develop good relationships with your customers and other stakeholders.
Like cash flows, profits play a critical role in your company's valuation.
Most buyers will look at gross margin ratios and other profitability ratios before looking at any other business valuation ratio.
So, if you're looking to fetch potential buyers, aim to improve your profits.
Analyze your processes and look for ways to improve operational efficiency, reduce expenses, and control inventories without affecting your operations. Rev up your sales and marketing without incurring significant costs.
Don't expect to get attractive offers if you're only breaking even. Your ratios should not only show profitability but also prospects for future growth.
Don't carry all the burden yourself.
Seeking advice can prove very helpful, especially when you're looking to improve your company's valuation.
Seek the services of professionals who are skilled in business valuations. An advisor can show you the areas of your business that need improvement and the steps to take to boost profitability.
Selling your business is one of the most important financial decisions you'll ever make as an entrepreneur. Seeking professional advice can help you get things right.
(For more tip on improving your business' valuation, see How to Increase the Value of Your Business to Sell It).
Wrapping Up
Selling your business is one of the most difficult decisions you'll ever make.
And the process can be hectic and strenuous. If your business valuation is on point, you will have a good chance to find a potential buyer. By following these tips, you'll be able to identify the criteria that matter most to potential buyers and improve the value of your business.
Larry Goldstein, Business Broker at First Choice Business Brokers