Value the business
A valuation of a going concern operating business is completed by using the income and market approaches (asset approach is rarely used to value going concerns unless they are holding companies). In the income approach valuation analysts normalize cash flow (officers’ compensation, rents paid to a related party, wages paid to inactive family members) and then apply a capitalization or discount rate to the income stream to quantify value. Normalize means we convert figures gleaned from tax returns or financials to economic reality.
For example, if a Dental Practice has a net after tax cash flow of $200,000 and the capitalization rate is 20% the value of the practice is $1,000,000. On the other hand, an example of the market approach is as follows: A CPA firm with normalized EBITDA of $350,000 would be valued at $1,400,000 using an EBITDA multiple of 4.0. The multiple is obtained from comparable sales databases like Dealstats or Peercomps. We might obtain more than 25 comparable sales for an accounting firm valuation.
Cash flow makes value soar. Increase the business cash flow by eliminating personal expenses ran through the business books.
If you are running $10,000 in personal expenses thru your books and your business is worth 4*EBITDA, you can increase the value by $40,000.
Plan
If you have not already done so plan what changes you need to make for the business to operate without you at the helm.
- Begin training your successor(s) to take your most important tasks
- If you don’t have a successor, consider a strategic alliance with a friendly competitor. You could have a buyout provision in the event of a triggering event.
Self-Reflect
Understand and prioritize market-related growth and equity drivers of performance/ value.
Identify where growth is occurring in the industry. Use current service lines to grow into those fast growth or value driver sectors.
Example: Landscaping company focusing on growing maintenance division i.e., recurring HOA, corporate clients etc. versus construction division i.e., buildout of new subdivisions. EBITDA 5x for maintenance and 3x EBITDA for construction.
Capitalize on Opportunities
Understand and prioritize operational growth and equity drivers of performance/ value.
- Identify strengths and opportunities in your organization
- The more the practice has income year-round, the more valuable the practice (e.g., bookkeeping, payroll, write up is more valuable to a buyer than income tax returns.)
- Local CPA purchased a second office within 20 miles of main office. Operating expenses were too high. Eventually second office was shut down.
Other
Identify, address and measure key risk components to minimize risk.
- Human capital, operating margins, recurring versus non-recurring revenue, days receivable outstanding, good books and records.
- Demand from individual customers and households is expected to decline due to a shift from in-person services to online based.
- Non-compete agreements are critical with key employees (according to a recent survey the organized labor force is the number one due diligence items that buyers are examining.
- Old receivables could be a red flag.
