Beyond the Balance Sheet: What Really Determines a Company’s Value on a Sale

One of the most common questions we get from business owners is: "What is my business really worth?" And while profitability is the obvious go-to answer, it's far from the whole picture. In fact, the true value of a business hinges on a lot more than just numbers on a P&L or Balance Sheet.

Written by: Taj Hussain

In this article, we’re diving deep into five key factors in determining what your business is really worth that may surprise you. We use the industry benchmark “EBITDA” (Earnings Before Taxes, Depreciation and Amortization”) throughout this article, which is for the most part your pre-tax profitability. Google it if you are unsure.

1.

The Usual Suspects – Profitability and Financial Health

Consistent revenue and profitability are important, but investors also value growth potential. We may see two similar companies with identical Revenue and EBITDA and think that both would sell for roughly the same price. If you factor in historical growth rate, you may see very different sale transactions—let’s compare two companies in identical (“traditional”) businesses to illustrate:

Company A: $20M Revenue, $4M EBITDA; 10% annual growth rate

Likely valuation range: 5x to 7x EBITDA: $20M to $28M sale price

Company B: $20M Revenue, $4M EBITDA; flat or volatile growth rate

Likely valuation range: 3x to 5x EBITDA: $12M to $20M sale price

It’s simple: Buyers prefer to buy companies where they just need to “put in gas” versus having to do a “tune up” to drive growth.

2.

Your Customer Base: “Safety in Numbers”

A diverse and stable customer base is essential for minimizing risk and maximizing a business’s value. “Customer Concentration” is the metric here.

Let’s look at our A’s and B’s again for an example:

Company A: $20M Revenue, $4M EBITDA; no single customer >10% of total revenue.

Likely valuation range: 5x to 7x EBITDA: $20M to $28M sale price

Company B: $20M Revenue, $4M EBITDA; one customer 40% of revenue.

Likely valuation range: 3x to 4x EBITDA: $12M to $16M sale price

Buyers really worry about losing a bunch of Revenue after they buy your company. If you lose that one single customer, the Revenue and EBITDA drop dramatically.

To enhance attractiveness, most businesses should aim for a balanced client distribution, ensuring no single customer makes up more than 10% of revenue and the top five together don’t exceed 50%.

Another important thing to note is customer tenure and churn. If you have a great distribution of client (as suggested above), but you lose and replace (“churn”) a lot of clients every year, that will likely affect your valuation negatively.

With this info, we have seen companies put a sale on hold, actively work on diversifying their Customer Concentration and churn over just a couple of years and come back to do a sale at a much higher valuation as a result.

3.

Competitive Edge: What Sets You Apart?

A strong competitive edge can greatly increase a business's value by making it different from others. For example, a company that creates a unique product with special features to solve a common problem will catch buyers’ attention. This difference attracts more interest from buyers because the product meets a specific need and is harder for competitors to copy. A company that has proven their ability to innovate and develop new or enhanced product or service offerings (or constantly enhance their current offering) will command a premium over the business that sells a commoditized product.

4.

Diversification Across End Markets: Can Your Company Weather Storms?

Broader economic and industry factors play a vital role in determining a company’s value. This is a somewhat obvious one, but companies often don’t realize the effect it can have on their valuation.

Below is how this may affect our A’s and B’s:

Company A: $20M Revenue, $4M EBITDA; provides recruiting services to tech, manufacturing and engineering sectors.

Likely valuation range: 5x to 7x EBITDA: $20M to $28M sale price

Company B: $20M Revenue, $4M EBITDA; provides recruiting only to manufacturing sector.

Likely valuation range: 3x to 5x EBITDA: $12M to $20M sale price

That diversification of revenue provides peace of mind to purchasers (just like diversification of customer revenue or product/service offering).

Being able to minimize the effects of a downturn in one of your end markets on your overall company performance is a big plus for buyers.

5.

Operational Strength: What if the Captain goes down?

The strength of a company’s management and operations can greatly affect its value. A Company with a strong management team that can run the day-to-day operations smoothly without relying heavily on the President will attract more interest from buyers. Similarly, if the business has clear processes and a solid succession plan in place (there is a #2 or even a #3 already in place that are ready to take the reins), it shows that it can continue to thrive even after the current leader steps away.

Here is how it may affect A & B’s valuations:

Company A: $20M Revenue, $4M EBITDA; diversified leadership, #2 and #3 in place.

Likely valuation range: 5x to 7x EBITDA: $20M to $28M sale price

Company B: $20M Revenue, $4M EBITDA; Retiring President, no succession plan.

Likely valuation range: 3x to 4x EBITDA: $12M to $16M sale price

Basically, if the Company is over reliant on one person to steer the entire business (and/or that person is looking to exit in only a couple of years), Buyers have to factor that risk into their pricing and purchase structure to mitigate their risk.

ALL IS NOT LOST! HOW TO PROTECT OR INCREASE YOUR VALUATION

It’s important to note that some of these variables can compound, negatively or positively. They can compound so negatively to the point where a company is not sellable at all, at almost any valuation. They can also combine to push a Company into “unicorn” territory, resulting in EBITDA multiples way above the typical range.

The good news is that if you are willing to be flexible on how and when you get paid out, you can reasonably expect to preserve valuation that would otherwise be lost because one of your fundamentals is not looking great.

If you know your fundamentals are trending positively, you can close a deal now but “bake in” appropriate “upside” consideration that allows you to regain lost valuation ground in the years post-closing.

An experienced M&A Advisor with a strong track record should be able to peg your valuation for you (before going to market), and help you structure a “win-win” deal to mitigate any (temporary) fundamentals of your business.