Have you ever wondered what determines the value of your business?
Perhaps you’ve heard an industry rule of thumb and assumed that your company will be worth about the same as a similar size company in your industry. However, when we take a look at the data provided by The Value Builder System™, we’ve found there are eight factors that drive the value of your business, and they are all potentially more important than the industry you’re in.
Not convinced? Let’s look at Jill Nelson, who recently sold a majority interest in her $11 million telephone answering service, Ruby Receptionists, for $38.8 million.
That’s a lot of money for answering the phone on behalf of independent lawyers, contractors and plumbers across America.
To give you a sense of how high that valuation is, let’s look at some comparison data. At Value Builder, we’ve worked with more than 30,000 businesses in the last five years. Our clients start by completing their Value Builder questionnaire, which covers 35 questions that allow us to place an estimate of value on a company. The average value for companies starting with us is 3.6 times pre-tax profit and those who graduate our program with a Value Builder Score of 80+ (out of a possible 100) are getting an average of 6.3 times pre-tax profit.
When we isolate the administrative support industry that Ruby Receptionists operates in, the average multiple offered for these companies over the last five years is just 1.8 times pre-tax profit.
Nelson, by contrast, sold the majority interest in Ruby Receptionists for more than 3 times revenue.
There were three factors that made Nelson’s business much more valuable than her industry peers, and they are the same things you can focus on to drive up the value of your company:
Cultivate Your Point Of Differentiation
Acquirers do not buy what they could easily build themselves. If your main competitive advantage is price, an acquirer will rightly conclude they can simply set up shop as a competitor and win most of your price sensitive customers away by offering a temporary discount.
In the case of Ruby Receptionists, Nelson invested heavily in a technology that ensured that no matter when a client received a phone call, her technology would route that call to an available receptionist. Nelson’s competitors were mostly low-tech mom and pop businesses who often missed calls when there was a sudden surge of callers. Nelson’s technology could handle client surges because of the unique routing technology she had built that transferred calls efficiently across her network of receptionists.
Nelson’s acquirer, a private equity company called Updata Partners, saw the potential of applying Nelson’s call-routing technology to other businesses they owned and were considering investing in.
Acquirers want to know how your business will perform after they buy it. Nothing gives them more confidence that your business will continue to thrive post sale than recurring revenue from subscriptions or service contracts.
In Nelson’s case, Ruby Receptionists billed its customers through recurring contracts—perfect for making a buyer confident that her company has staying power.
In addition to having customers pay on recurring contracts, the most valuable businesses have lots of little customers rather than one or two biggies. Most acquirers will balk if any one of your customers represents more than 15% of your revenue.
At the time of the acquisition, Ruby Receptionists had 6,000 customers paying an average of just a few hundred dollars per month. Nelson could lose a client or two each month without skipping a beat, which is ideal for reassuring a hesitant buyer that your company’s revenue stream is bulletproof.
Nelson built a valuable company in a relatively unexciting, low-tech industry, proving that how you run your business is more important than the industry you’re in.
Will this be the year you seriously drive up the value of your company?
If you have resolved to make your company more valuable in 2017, you may want to think hard about how your customers pay.
If you have a transaction business model where customers pay once for what they buy, expect your company’s value to be a single-digit multiple of your Earnings Before Interest Taxes, Depreciation and Amortization (EBITDA).
If you have a recurring revenue model, by contrast, where customers subscribe and pay on an ongoing basis, you can expect your valuation to be a multiple of your revenue.
Breedlove & Associates Sells for 6X Revenue
In 1992 Stephanie Breedlove started a payroll company to make it easier for parents to pay their nannies on a recurring basis. It began small and Breedlove self-funded her growth, which averaged 20% per year.
By 2012, Breedlove & Associates had hit $9 million in annual sales when Breedlove accepted an offer from Care.com of $55 million for her business—representing an astronomical multiple of more than six times Breedlove’s revenue.
Buyers pay up for companies with recurring revenue because they can clearly see how your company will make money long after you hit the exit.
Not sure how to create recurring revenue? Here are four models to consider:
Products That Run Out
If you have a product that people run out of, consider offering it on subscription. The retailing giant Target sells subscriptions to diapers for busy parents who don’t have the time (or interest) in running to the store to re-stock on Pampers. Dollar Shave Club, which was recently acquired by Unilever for five times revenue, sells razor blades on subscription. The Honest Company sells dish detergent and safe household cleaning products to environmentally conscious consumers and more than 80% of their sales come from subscriptions.
If you’re a consultant and offer specialized advice, consider whether customers might pay access to a premium membership website where you offer your know-how to subscribers only. Today there are membership websites for people who want to know about anything from Search Engine Marketing to running a restaurant.
If you bill by the hour or the project, consider moving to a fixed monthly fee for your service. That’s what the marketing agency GoBrandGo! has done to steady cash flow and create a more predictable service business.
Ask yourself what your “one-off” customers buy after they buy what you sell. For example, if you make a company a new website, chances are they are going to need somewhere to host their site. While your initial website design may be a one-off service, you could offer to host it for your customer on subscription. If you offer interior design, chances are your customers are going to want to keep their home looking like the day you presented your design, so they might be in the market for a regular cleaning service.
If you offer something expensive that customers only need occasionally, consider renting access to it for those who subscribe. ZipCar subscribers can have access to a car when they need it without forking over the cash to buy a hunk of steel. WeWork subscribers can have access to the company’s co-working space without buying a building or committing to a long-term lease.
You don’t have to be a software company to create customers who pay you automatically each month. There is simply no faster way to improve the value of your business this year than to add some recurring revenue.