A profitable business and a sellable one are not the same thing. Buyers pay for what the company will earn without you.
Owning a profitable business and a sellable one are two different things. You can technically sell an unprofitable business to a willing buyer, and you can certainly have a very profitable business that is unsellable. As a business owner, you know how important profits and cash are for your success, but so is the value of your company. And a company’s value comes from more than just profits.
Many business owners in America think about selling their companies as a potential exit or retirement strategy. When they start seriously considering the situation, they realize that company value is not the same as profitability. Profitability is the ability of a company to make money in a given period of time. A company valuation, on the other hand, comes from the expectation of future cash flow into the company. It’s the value a willing buyer assigns to the future of what the company can accomplish.
If you are even remotely thinking about selling your company in the near future, here are three things that erode valuation, even if your business is profitable: owner dependency, customer concentration, and messy financials.
Owner dependency
Business owners are founders by nature. It is normal for them to be key to the success of their company. But can the company survive without you? If the answer is not a resounding yes, you might not have a company ready to be sold.
Owner dependency takes the form of the owner having all or most direct customer relationships. They might be the only ones who “really know how the company works.” It can also take the form of an owner who does a little bit of everything and whose input is needed for almost every decision. This is a major risk for a potential acquirer, simply because they are not you. If you are the main driver of the company’s value, and the company is not going to have you around in the future, then the value of the business would be significantly eroded if it changed hands. For most buyers, it is simply too risky.
The good news is that there are easy fixes. You can implement processes, SOPs, practices, and trainings that empower your employees to be more independent. These actions make your company run more like an entity that can survive without you. They also have the extra benefit of freeing up your precious time. It’s a win-win for you and for your business value.
Customer concentration
If a large percentage of your revenue comes from a single customer or a small set of customers, your company value is going to be less than if you have a robust mix of multiple customers. It simply comes down to a risk assessment. What happens if tomorrow this mega client changes their mind and decides to leave you? How is your business going to recover from such a loss? A potential acquirer evaluates that risk and penalizes the value of your business.
To deal with this issue, always look for ways to diversify your customer portfolio. If a customer is getting too big, it might be an opportunity to improve your business development and start getting more new customers. That way, your performance and profitability don’t depend on a single client.
Messy financials
Even though a business valuation is based on the future outlook of the company, the initial assessment is based on current performance. If the company is capable of making money today, it is fair to assume it could be capable of making money tomorrow. Therefore, the performance information we have from the present is key to understanding the potential future.
If a company has messy financials, it’s like a student who didn’t do their homework. They might know all the topics, and they might be really smart, but they have nothing to show to prove it on the spot. For a potential acquirer, taking your word that the company will be able to generate cash flow in the future is simply too risky without proper financial statements and other relevant information to back that claim up.
Messy financial statements take multiple forms: mixing personal and business expenses, over-relying on cash transactions that are difficult to prove and track, or committing accounting errors. The best moment to take corrective action on these aspects was yesterday. The second-best moment is today. As a business owner, you don’t know when the desired selling opportunity is going to arrive. It is better to always be prepared.
Getting ready for the right opportunity
If you are a business owner facing the journey of transforming your profitable business into a sellable one, know that an outside perspective can help you. Potential acquirers look for companies that can work independently, that have clear financial information, and that do not depend on a single customer’s mood. Getting ready for the right opportunity can be the path to your desired exit, where you can reap the rewards of your hard work as an American business owner. And it can be worth millions in company value.
