Most sellers are aware that that there are “rules of thumb” or industry standards that suggest that businesses in certain industries should sell for a specific multiple of revenues or cash flows. Many times sellers are disappointed that there business does not generate offers at or near the “rules of thumb.” This can happen for a variety of reasons – you can be selling at an inopportune time or, for a variety of reasons, your business may not be attractive to the buyers who are willing to pay top dollar.

One important issue is that there are two general types of buyers for a business, one is a financial buyer and the other is a strategic buyer. A financial buyer is buying a business in order to earn a return on his investment and/or to provide himself with a job generating earnings. These buyers will generally offer less for a business because it is critical for them to earn a return from their investment directly. A strategic buyer will view an acquisition opportunity differently. The strategic buyer is usually already in the same industry, sometimes in the same market. They may view an acquisition as either an opportunity to extend their market area or to increase the market share they already have in a given market area. These acquisitions are often called “tuck-in” acquisitions and often produce the highest offers because the buyer may already be incurring many of the overhead costs associated with operating the business to be acquired. As a result, they may be able to generate more incremental earnings out of an acquired business than a financial buyer could and, as a result, may be willing to pay a higher price.

This is a difficult concept for many sellers to grasp, but it is reality. The business you have successfully built up may be worth more folded into a larger business than as a stand-alone business perpetuating the business style that has given the entrepreneur who has built the business the success he has realized thus far.

In strategizing about a potential business sale, it is important, then, to consider who the likely purchasers are and focus on making the business desirable to the best buyers.

Understand the Value Drivers for Your Business

To a certain extent, the value drivers will depend on who the most likely buyers for your business are. Financial buyers, who plan to acquire and operate the existing business to produce a return will be interested in different facets of the business than a strategic buyer who plans to “tuck-in” the acquisition into an existing operation.

In general, however, the biggest drivers of the value of your business will be the profitability of your customer base and its stability. You are already used to being concerned about those issues, but now it is important to view them from a potential buyer’s perspective.

Recurring revenue is of the greatest value to buyers – revenue from loyal customers who purchase the same services year after year. In evaluating the profitability of the recurring revenue of your customer base, you have to consider both pricing and what a buyer’s cost structure is likely to look like.

For example, strong pricing on a service line that a buyer currently offers or is prepared to offer is of greater value than on service that a buyer does not currently offer and will have to obtain resources – people, equipment, etc. – to perform. An example is a lawn care service that also offers tree surgery, which is performed by its owner. If the tree surgeon-owner does not plan to stay with the business after a sale, a competing lawn service contemplating an acquisition would have to acquire both the equipment and personnel to perform this service, making that portion of the revenue much less valuable than the lawn care service he can easily incorporate into his existing business.

In general, buyers will consider basic recurring services to be more valuable than add-ons, which are sometimes called “expanded services” or “beneficial services.” Why are basic services more valuable than add-ons? One reason is that basic services are performed according to a set schedule and usually auto-renew, meaning that the customer has agreed that he or she will continue to receive the service until the customer cancels the service. Add-ons, on the other hand, cover a very wide range of other services provided to customers. They may include such services (for lawn care) as core aeration, seeding and over-seeding, grub control, fungicide treatments, brown spot treatments and a host of others.

What is different about expanded services that makes them intrinsically less valuable? The most important reason is that they usually do not continue from year-to-year automatically. As a result, not only are they less certain than basic services, but the business must incur additional selling costs, possibly including commissions, in order to generate those revenues each year.

In many cases, there are add-ons that a significant portion of the customer base takes each year, such as grub control in regions where damage from grubs is common. What can a business owner do to increase the value of such add-on services? One strategy is to include them as part of basic services, possibly as part of a “premium” program. Another is to set them up as auto-renewing in their own right. Most buyers will consider auto-renewing add-ons as more valuable than others.

One other comment about add-on services is worthy of special note. A wide range of highly-specialized services will be of less value than a large volume of less specialized services. This is especially hard for many business owners to accept since they may have built their business by being the “go-to” expert on specialized problems. For the most part, except in very specialized circumstances, most companies that are making acquisitions are seeking to add high-volume, standardized services.

I would never recommend that a business owner who has built their business this way make a dramatic U-turn and only provide high-volume, standardized services, but I would suggest two things. First, I would recommend that they structure their services in as standardized a way as possible and as far as possible, completely avoiding hourly-rate consulting services, which many buyers will assign little or no value to. Secondly, I would focus, where possible, on the recurring nature of the services.

Either kind of buyer will be interested in the stability of the customer base and how likely your customers will be to stay with the buyer after the sale. One indication will be how long the customers have been your customers. Another way to look at stability is to track what percentage of customers cancel services every year. You may be maintaining your customer base in two completely different ways – maintaining customers year after year or you may have a high cancel rate but be successful in aggressively adding new customers every year. All other things being equal, the stable customer base will be worth more to most buyers as they will need to factor in the cost of replacing canceling customers into their valuation analysis.

The buyers will also consider subjective factors in evaluating the stability and quality of the customer base after the sale. They will be considering questions like the following: Will retaining key employees of the seller help retain customers? Have the buyer and the seller been fierce competitors? Are many of the seller’s customers former customers of the buyer? Is the buyer familiar with many of the seller’s customers? Will the buyer continue to use the seller’s trade name after the sale?

The more data that you can provide the buyer about the customer base, the more satisfied the buyer is likely to be.

Share →

Leave a Reply

Your email address will not be published. Required fields are marked *

8 − = 6

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

Looking for something?

Use the form below to search the site:

Still not finding what you're looking for? Drop us a note so we can take care of it!