Questions & AnswersEvery Question Deserves Consideration
Practical answers to questions privately held business owners frequently ask. These initial questions reflect situations encountered during years of business ownership, valuation, and sales—not purported reader submissions.
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How do I know what my business is worth?
It's a question every business owner should ask, whether they're planning to sell next year or have no intention of selling for another twenty years.
In my experience, owners often develop an idea of value based on what they've invested, how many years they've worked, or what they've heard another business sold for. Those considerations may be personally meaningful, but they don't necessarily determine what a buyer will pay.
I begin with current cash flow, recent performance, industry reputation, management independence, customer relationships, and the assets and obligations involved. Two businesses with similar sales and earnings can have substantially different values because one presents greater risk to a buyer.
I also distinguish the value of a business from the amount its owner ultimately receives after financing arrangements, transaction expenses, taxes, and other considerations.
My advice is to understand your business's approximate value long before you're ready to sell. That gives you time to improve the factors within your control.
The important question isn't simply what your business is worth today. It's what you can do to make it more valuable tomorrow.
Why isn't my business worth a multiple of annual revenue?
Revenue tells me how much business a company does. It doesn't necessarily tell me how much money the company makes or how attractive it is to a buyer.
Consider two companies, each generating $5 million in annual revenue. One consistently produces $800,000 in annual operating cash flow. The other produces $150,000. Assuming other circumstances are comparable, buyers will value these companies quite differently.
But cash flow doesn't tell the entire story. A company may depend heavily on one customer, require substantial future equipment purchases, or rely on the owner's personal relationships. Another may have recurring revenue, strong management, and opportunities for expansion.
Certain industries use revenue multiples as benchmarks, particularly where recurring revenue makes them meaningful. Applying a generic revenue multiple to every privately held business can be misleading.
I prefer to understand operating margins, capital expenditure requirements, working capital needs, competitive position, and the sustainability of earnings before discussing valuation multiples.
Revenue establishes the size of a business. It doesn't, by itself, establish its value.
Why are buyers concerned when a business depends heavily on its owner?
One of the first questions I consider is: What would happen if the owner unexpectedly stopped coming to work tomorrow?
Would customers continue placing orders? Would employees know how to handle problems? Would important decisions still get made?
Many businesses succeed precisely because their owners are talented and deeply involved. But the qualities that make an owner successful can make the company difficult to transfer.
I've encountered businesses where the owner maintained nearly every important customer relationship, approved virtually every decision, and possessed technical knowledge never shared with employees. A buyer must consider whether profits will continue after that owner leaves.
The solution is to develop an organization that can function independently: capable managers, transferred customer relationships, documented processes, and greater employee authority. These improvements take time.
A business that can operate successfully without its owner is generally more transferable—and often more valuable—than one that cannot.
Is it better to sell my business while it is growing?
Generally, I would rather represent a business with demonstrated growth than one experiencing unexplained declines. But growth alone doesn't guarantee a higher valuation.
I like to examine approximately five years of operating results, emphasizing the most recent two years. Is growth consistent, temporary, or driven by unusual circumstances?
A buyer wants to know whether the company is gaining market share, introducing successful products, benefiting from industry growth, or merely recovering from a weak prior year.
Rapid growth can strain equipment, inventory, employees, and working capital. A manufacturer already at full capacity may need substantial investment to grow further. One with available capacity may be more attractive.
I've also seen owners postpone selling because they expect another year or two of growth to increase the price. Sometimes they're correct, but additional value must be weighed against the time and risks of waiting.
The best time to sell is not necessarily when revenue reaches its highest point. It's when the business is attractive to buyers and the timing makes sense for the owner.
How much does customer concentration affect the value of my business?
Customer concentration is one of the most important risks I examine. Suppose half of a company's revenue comes from one customer. Even a longstanding, profitable relationship creates risk if it ends.
There isn't one percentage that automatically makes concentration unacceptable. The real issue is the financial damage that losing a customer could cause, particularly where fixed costs are high.
There's another form of concentration owners overlook: hundreds of customers can still depend on the same industry. An industry downturn could affect many at once.
Customer diversification should be examined by individual customer, common ownership, industry, geography, and sometimes product or service. The related story ‘When Many Customers Suddenly Become One’ explores how acquisitions among customers can create concentration almost overnight.
Reducing concentration takes time, another reason to consider business value well before a sale.
A dependable customer base is valuable. A dependable and diversified customer base is generally more valuable.
How important is having a management team in place before selling?
In many privately held businesses, the owner and perhaps a spouse handle work that would be divided among several managers in a larger company.
That may work well for years. The difficulty appears when the owners decide to retire. A buyer needs an organization capable of continuing operations, not merely equipment, inventory, and customers.
I sometimes call this the company's management chassis: the people, responsibilities, systems, and processes supporting the business.
A small company needn't have a large executive team. What matters is whether important functions can continue without depending entirely on the departing owner.
A strategic buyer may absorb certain responsibilities; an individual buyer may need more management already in place. Either way, management independence reduces transition risk.
A buyer isn't simply purchasing what the business accomplished under its current owner. The buyer is purchasing the opportunity for that business to continue succeeding afterward.
Should I wait another two years before selling my business?
I've had this conversation with many owners approaching retirement. The company is doing well, and another year or two might produce more earnings and a higher price.
But I encourage owners to consider what they're giving up. Someone financially able to retire at 68 who waits two more years is also postponing two years of retirement.
Those years have value, even though they don't appear on a financial statement. Economic conditions, customers, key employees, competitors, and health can change unexpectedly.
The decision deserves more than an estimate of future valuation. Consider likely additional after-tax proceeds, risks, financial needs, and what the owner hopes to do after leaving.
Sometimes waiting makes sense. Other times, the owner is already in an excellent position to sell and has little to gain by postponing the next chapter of life.
Consider not only the value of the company, but also the value of the time remaining to enjoy the rewards of building it.
Why isn't the highest purchase price always the best offer?
The purchase price is only one part of a successful sale.
Consider a $4 million offer payable entirely at closing and a $4.8 million offer involving seller financing, an earnout, and several years of continued involvement. The second price is higher, but is it better?
That depends on the seller's objectives and willingness to accept risk. An owner eager to retire may prefer the first; another comfortable staying involved might prefer the second.
Buyer financing, representations, indemnities, note default risk, and taxes can materially affect the outcome.
I believe owners should compare expected net proceeds, timing, certainty of payment, continuing obligations, and the buyer's ability to operate successfully. Employee welfare or legacy may matter too.
The best offer is not always the one with the largest number on the first page. It's the one that provides the most satisfactory overall outcome for the owner.
General educational information based on professional experience, not individualized valuation, financial, tax, or legal advice.