Valuation Playbook: 5 Ways to Maximize Your Company's Value

How Can You Maximize Your Company’s Value Prior to Selling It?

Selling a company is like jumping out of a plane for most entrepreneurs.  A skydiver jumps from an altitude of 13,000 feet; giving them about 60 seconds to free fall to their desired destination. At the start, the landscape below is small and unfocused but as the diver gets closer to the ground everything becomes much more clear.   The details of the wind, geography and other elements allow them to plan for a successful landing. Success at this task requires solid preparation, reliable equipment and skilled mentors. Selling a company is similar in that everything isn’t in perfect focus upfront but with the right approach and preparation you can achieve significantly greater success – and a higher valuation.

According to our Entrepreneur Exit Report, 34.5 percent of respondents actively plan to sell their company within 18 months and 47.9 percent are actively evaluating a sale. What’s more, 23.71 percent of entrepreneurs said that valuation is the most difficult part of a sale; the No. 2 answer was finding the deal.

So, how do you achieve a higher valuation when selling? Headlines about large sales for hundreds of millions of dollars capture attention and leave entrepreneurs wondering how they can secure a deal like that. The answer isn’t always what you would expect, and it includes strategies that aren’t on the radar of most entrepreneurs.

What entrepreneurs believe creates value

Our recent survey asked entrepreneurs what created the largest impact on their company’s valuation. The majority of entrepreneurs believed the growth rate of the company played the biggest role in how much their company was worth.

Business owners are focused on growth because they are working to maximize a company’s value based on their perspective, meaning, “How can I increase what my company is worth to me?” This strategy makes sense if you have a lifestyle business or no intention of selling in the future. But if you seek an exit or liquidity opportunity, there are many factors that play a critical role in maximizing your company’s value. The below graph shows what entrepreneurs believe creates the most value, and business owners put Growth Rate as the top value creator.

We also asked Private firms and Investment Bankers what they believe creates the most value for a company. Both agreed that the No. 1 factor isn’t growth. Investment Bankers, who primarily seek to get a transaction complete overwhelmingly put Quality of Earnings as the top value creation (Suggested Reading: What Entrepreneurs need to know about using an Investment Banker or Business Broker), but as seen in this chart, PE Firms put Competitive Advantage:

Why is Competitive Advantage more valuable to Private Equity firms? Because Competitive Advantage drives Growth, Revenue and Profit. It is the cause of the Cause/Effect relationship. That means Growth, Revenue and Profit are lagging indicators if you have a competitive advantage. The more you focus on expanding your advantage the better your sales & marketing results should be. PE Firms know they can improve your sales & marketing functions to grow much more easily than building out a clear competitive advantage.

But what creates value? Most entrepreneurs consider a few major items, including growth, profit and revenue, when thinking about what increases the value of their company. And while these are important to the sale of the business, there are critical strategies that most owners haven’t figured out.

Before we go into how to create value, it is important to know that most entrepreneurs do not know the value of their company. In our research, 36% of entrepreneurs believed their valuation was 100% higher than their industry average or 30% believed it was significantly lower.

I believe these are related, if entrepreneurs better understand how value is created they would have a better sense of what their company valuation might be.

The 5 Value Creation Buckets

There are five main “buckets” of value creation that a company can use to maximize its valuation. The first two, growth curve and scalable framework, are on the radar of most companies. But the last three, valuation multipliers, building a leverageable organization, and the exit thesis (story) are where the “secret sauce” is created. Pulling the lever on all these strategies creates a situation where a seller receives a much higher sale price. Let’s take a look.

1. Moving up the Growth Curve

Key Metric: YOY Growth

What is your company’s ability to predictably grow and on the speed of that growth through sales and marketing. How quickly can a company get new deals? Is the company set up so that securing new business through marketing and sales is easy? Growth is key, but it is a result of two main things your competitive advantage and demand control.

The leading indicator to focus on for growth is a company’s competitive advantage. Defining your competitive advantage and how it drives growth, revenue and profits is critical. Buyers considering the purchase of your business know that if you solve a real pain point and have a competitive advantage, your company is worth more. The more you focus on solidifying this advantage, the higher the sale price.

How do you know if you have a competitive advantage? I'll unpack this in more detail because too often I've worked with companies who think they have one but do not.

1. The 10x Test (aka the Ben Horowitz Test) Ben, renowned venture capitalist at firm Andreessen Horowitz says:"The primary thing that any technology startup must do is build a product that’s at least 10 times better at doing something than the current prevailing way of doing that thing. Two or three times better will not be good enough to get people to switch to the new thing fast enough or in large enough volume to matter." Do a Win/Loss analysis on your past opportunities and see if you close a high percentage.
2. The 80% Break Through the Noise Test. Typically 80% of the market is not actively looking to make a change in whatever you are selling. If you went into a room of people who could be your customer, would they be interested in engaging what you have because your product or services are compelling enough? Try a Cold Email or Calling campaign and see if you can generate new sales to see if this is in place.
3. The Vitamin or Painkiller Test. Lastly, when these people become interested, is the focus on the business outcomes and value you create with your competitive advantage or do they focus on price? If I am in massive pain with a migraine, I always take a painkiller, but although I do believe it's good for me I skip weeks between taking vitamins, even though I have them in my house. Can you quantify your advantage so that it measurably impacts their business, such as "on average our offering increases the number of qualified lead in your sales pipeline by 25%". The focus should be on buying the pain relief (critical business outcome) not the features of the pill (features, demo requests to look at it, etc).

Demand Control is the second part, which means how confident are you to accurately invest money into sales & marketing and know what your results will be. Where do your leads come from and can you build a scalable plan to increase the number is a predictable way.

Potential buyers also want to evaluate your growth rate. What is the company’s history of growth in the past, and what is the opportunity in the future? Does the company have any proprietary intellectual property or technology? These elements all play into how much a buyer is willing to pay for your company.

If you don't have the YOY Growth results you need, there are several ways you can solve this often starting with a customer development process.

2. Having a Scalable Framework

Key Metric: Gross Margins & Capital Efficiency Ratio

A company might be profitable today, but how does that company hold up when the buyer ramps up growth? Can the business handle growth under the current framework? Is there proprietary IP or technology that allows the company to stay efficient and keep costs low? Is operational efficiency maximized? For each new dollar invested will it make more? Securing the maximum sale price depends on these factors.

Building a scalable framework also includes the management and leadership team. If a buyer decides to aggressively grow in the future, can the current leaders handle that growth? If so, the value of that company is greater. If a company knows it plans to sell, it can create a management team that is designed with these considerations in preparation for that sale.

In working with a lot of companies two rules I share that are key relate more to having a disciplined mindset as the leader:

Rule #1 Good Opportunities are the enemy of Great Singular-Focused Intentionality. Is your team operating from a clear plan that drives decision-making and execution toward a shared vision?

Rule #2 Make the transition from “Entrepreneur” to CEO of your business. Are you as the business owner able to work more 'on' the business than 'in' the business?

Companies who do well in this invest in Strategic Planning, have an Executional Framework and are becoming more efficient through Business Process Mapping (and Tech Enablement).

3. Targeting Valuation Multipliers

Key Metric: Valuation (Exit Multiple)

Having a strong competitive advantage, excellent growth and a scalable framework is a good starting point for driving greater value, but what else can be done? There are key Valuation Multipliers that play a big role in your valuation. For example:

The type of revenue you earn. Do you earn transactional, project-based, managed service or software-as-a-service revenue? The type of revenue you earn can move the needle on how much buyers are willing to pay. For example, a company with a SaaS model will yield a higher price than one with a project-based setup.

A company decided to sell but finds that valuation and interest in the purchase of its business is low. As a result, the company decided to use a “valuation multiplier” and change how it’s earning revenue. The company changes from a project-based revenue structure to a SaaS revenue structure to increase its value. The owner says,

"We knew we had to make a jump to subscription pricing and software as a service. But there's a lot of inertia against making changes to pricing. Initially it was a pretty tough transition, but we decided we had to do it. Ultimately this change led to us getting an offer 4x bigger than we had based on our previous revenue model."

In this situation, changing the revenue structure quickly increased interest in the company, and as a result, the company secured more offers and a higher purchase price. Sometimes this strategy is counterintuitive. A company might earn less revenue in the short term by changing its revenue structure. But if you want to sell, you need to ask what kind of revenue, contract terms and mix will be most valuable to the acquirer of the company.

The company size and valuation. Another example is the size of the company and its potential value. Reaching $20M in value can be a magical hurdle because often buyers can't engage in a company smaller than this level. It's too risky and takes too much time compared to the potential impact.

A couple rules on targeting this include:

Rule #1 Know the Counter-Intuitive moves based on your desired outcome.  The example of the company moving to SAAS also involved them making less money initially when compared to doing their services on a project basis.

Rule #2 Pick a big valuation or multiple move and go all-in. What will move the needle? Look at M&A activity in your industry why are some firms getting 5x EBITDA versus 8 or 12x? What are the growth rates of the companies receiving higher multiples. Is it because of the deal structure? Are your contracts 6-months but include a 30-day out? It may be better to close few deals but have more predictable revenue contracts. Another big move I've seen several times is merging with another company prior to or at the exit to drive up the valuation for both firms.

There are a number or levers you can pull on to increase the value, like taking advantage of the timing of selling, add-back strategies and pricing models. Create the math of the outcome you want to achieve and reverse engineer this into your company.

4. Create a Leverageable Organization

Key Metric: Post-Acquisition Economics

Unlike real estate transactions, there is no Regional Multiple Listing Service for businesses where you can quickly determine the value of a company. A few major factors go into the sale of real estate, but there are dozens and even hundreds of factors that go into the sale of a business. One major factor is understanding the value of your business “below the surface.”

For example, I was once involved in purchasing a company for $30 million, but it was worth over $90 million to us due to factors that weren’t obvious during the valuation period. As a result, the seller leaves a large sum of money on the table. Another company planned to sell for $65 million, but found that its business was worth much more to strategic buyers. As a result, the business received more than double its projected asking price and sold for $150 million.

Don't just sell your company for what it's worth (financially) but what it's worth to them. How do you find a buyer to acquire your company based on a strategic value, not just what it's worth financially?

Rule #1 Map the Industry Value Chain for your customers. Identify who makes more on your customers than you do.

Rule #2 Do the Synergy Math. If the company was to buy you, could they sell to your customers? Could you sell to theirs? Build out what the math could look like after the acquisition is complete to understand what your value is to them.

5. Write the Exit Thesis (Story)

Key Metric: Strategic Valuation

How can you create and communicate your story to potential buyers clearly and powerfully to achieve an ideal exit? Creating a clear Exit Story is one of the most missed steps in the M&A process. In our experience, owners are too close to create this story and Investment Bankers often focus on the financials and facts to get a deal done.  This is a costly mistake. This is one of the most important sales and marketing roles a business owner has and they need a compelling story backed by solid data for the exit process

In addition, don't present a generic deck and hope buyers 'get it'. Math wins. Know each Buyer’s desired outcome, the math and strategic drivers and deal rationale and present your deck with the buyer as the hero of the story.

Conclusion: Securing a higher valuation for your Company  

According to entrepreneurs, one of the most difficult parts of the sales process is the valuation. In fact, it’s a major reason why most deals don’t close. Research shows that only 20 to 30 percent of businesses that go on the market actually end up selling.

Entrepreneurs can start planning for the sales of their businesses months in advance by actively working on these five buckets. But the secret sauce that helps significantly grow the valuation is in the last two buckets. As a result, you can exceed all previous sale price expectations — doubling or even tripling the purchase price of your business.

Want to learn more? Grab your copy of the Valuation Playbook.