We have all heard the stories about how someone in our industry was able to sell their business for an unbelievable multiple. These are the stories that all business owners who want to sell aspire to. That magic multiple that makes selling your business make sense. Are these just “fish tales” like we are told as kids? Or are these the stories that make dreams come true? Every business owner may have a different answer to that question. Whether you are looking to land a big offer or provide a legacy for the next generation, the answer lies in what you are doing today. Are you setting up your business to have the greatest enterprise value possible?
I recently attended an industry event where our Chief Financial Officer (CFO) spoke to other CFOs about how to increase the value of their company. The concepts may seem simple, but the execution may mean the difference between telling a whopper of a story or just a simple fish tale.
First, it’s important to consider that if you are like most small business owners, 80-90% of your assets are tied to your business, so knowing its value is important for several reasons: retirement or estate planning, future need to add debt or equity, acquiring another company, expanding lines or products, or planning for a full exit. At the end of the day, driving higher business valuation just makes sense.
We all know there are many methods for valuing your business, including discounted cash flow, multiples of EBITDA or earnings, but ultimately the market, not the formula determines value.
So, with that in mind, here are a few questions to consider:
- Is your industry in or out of favor with potential investors?
This will depend on the acquiring company. They will determine if the industry will provide for a capital gain someday. With the number of acquisitions happening recently, the office equipment industry appears to be in favor with many investors. - Does your company have consistent financial performance?
Investors view profit as essential, but will also review how your company compares to industry averages and benchmarks. Are you tracking your company performance against industry benchmarks? - What is the current growth rate of your company?
Steady consistent growth is a sign of a historically solid business strategy. - Do you have a marketable differentiation from your competitors?
Having a diversified product mix and strong marketing presence in your market area gives your business an edge that investors are seeking. - Do you have a solid leadership and sales team?
Tenured leadership within the executive and sales teams provides investors with confidence in your company’s ability to execute. - Is your customer base diversified? Let’s explore this more.
A diversified customer base is essential to increase the value of your business. Value is driven by expected future revenues and profitability. This is tied to the diversity of your customers.
What are the customer factors to consider?
Customer Concentrations: Are you too dependent on a single customer?
Customer Loyalty: How have you been successful in renewing your customer contracts to maintain your machines in field?
Recurring Contracted Revenue: Do you have your service and supplies under contract?
Why Contracted Revenue?
Contracted Revenue is the highest form of recurring revenue you can obtain. You ensure your future revenues are secure by bundling your service and supply payment onto the monthly lease payment. Other benefits of bundling include: protecting your customer base from competitors, adding opportunity for increasing your service and supply margins, and increased retention rates. We found that customers that do not bundle through contracts experience a 70-75% retention rate. However, bundled contracts renewed 90-95% of the time. This can be a meaningful economic advantage for an office technology dealership.
An example of the power of customer retention with bundling:
Let’s assume you currently have $5,000,000 in annual recurring revenue. Typically, your company experiences 20% growth in new recurring revenues and you lose 15% of your revenues each year. This leaves a net growth rate of 5%. Let’s look at two scenarios to see the impact of relatively small changes.
Scenario 1 – you improve your retention rate from 85% – 90%. This is within the range most bundling dealers experience.
Scenario 2 – you add a 5% escalator to your service and supply revenue annually.
How does this affect your overall contracted revenue?
With an annual net growth of 10% vs 5%, Year 5 revenue is 26% higher than the base year and Year 10 revenue is 59% higher than the base!
But wait, look what happens when you also add 5% escalations to the contracts. Year 5 revenue is 58% higher and Year 10 revenue is 148% higher than the base year!
This has a huge impact on the valuation of your company.
There are many drivers for increasing the value of your business. Some require strategic thought, but others, like bundling your service contracts into a finance agreement with escalation, can have dramatic effects with very little change to your overall strategy.
Deep thought on these questions will help to optimize your company’s enterprise value. This value provides alternatives for capital gains if you are looking to sell someday. More importantly, it will also create a business that has sustainability and longevity if you are building a company to last.
What are you waiting on? It’s time to make the strategic decisions that drive your entity’s value!
