We all know the answer to this…whatever someone is willing to pay.
It’s true, but not massively helpful when planning the strategic direction of a company and how you, as the owner, may sell it one day for a pleasing sum of money.
The formula generally used to value a business is: Value = Profit x Multiple
Put simply, when someone buys your business, they are paying for a number of years of profit in advance. The multiple is the key to how many years.
When we think of growth and increasing value, most of us think about making more profit. If we make more profit, the business is worth more. It’s simple, easy to explain and not necessarily a bad strategy.
The problem is that for most, growing profitability isn’t as easy as clicking your fingers.
It’s also easy to spot that there’s another way to increase the value: make the multiple a larger number.
The majority of company owners know how to increase their profitability, not as many know how to increase the multiple.
Increasing the multiple is such a huge topic that there’s an entire industry built around it! This article won’t demystify the entire subject, but hopefully will demonstrate how vital increasing the multiple can be.
This drawing is a snapshot of one of Shirlaws valuation frameworks. You’ll see the benchmark line, which is what the average multiple is for a particular industry at a particular time.
For example, if you make office furniture, the benchmark average will probably be around 6. If you’re in Silicon Valley running a tech outfit, it’ll be much higher.
For the sake of simple maths however, let’s assume your industry benchmark multiple is 6 and your profitability is £1M. Your business at benchmark is therefore worth approximately £6M.
Let’s 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 6 to roughly 7.2, adding £1.2M on the value of your business.
For the vast majority of businesses, it is much easier, quicker and less expensive to improve the culture than 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.
So in summary, yes, 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, like a strong culture, that will continue to make money in the future.
For more information on how our frameworks and methodologies can help increase the value of your business, download our free eBook, The Reality of Exit Strategies, contact us or book a place on one of our Discovery Sessions for more information.
