Entrepreneurs who are savvy about growing their ventures spend a lot of time thinking about growth strategies. The truly wise ones aren’t just thinking about growth – they’re simultaneously strategizing a successful exit.
After all, most business owners inevitably leave their business. Only some are going to do it on their own terms and get a reasonable return for their efforts. The question is: how?
First, it’s about mindset.
You know the saying “Turn down for what?” This millennial catchphrase may seem removed from talk of revenue and earnings trends, but when it comes to selling a business, it’s spot on.
The absolute best way to exit a business like a boss is to sell while demonstrating fantastic growth. The vast majority of companies are sold based on past performance.
What’s Your ROI On Sweat and Tears?
Growing a business is hard work. Growing it with a strategy for your eventual sale of the business is how smart founders get the highest return on their sweat and tears.
To put this into context, consider these examples. Each hypothetical company been successful, but their past performance is directly tied to the value of the business when it’s time to sell.
Betty’s Plumbing, a commercial plumbing contractor, has generated $2 million in EBITDA (i.e., earnings before interest, taxes, depreciation, and amortization) for the last several years. The buyer values it at some multiple (say 5x) of that number, and they all go on their merry way.
But selling a business isn’t usually this straightforward. Executives and entrepreneurs often want to get compensated for the effort they put into getting to that $2 million in EBITDA. A premium, if you will.
Unfortunately, most buyers can’t afford to pay a premium on Betty’s Plumbing – it’s a known commodity, earnings are consistent, and there is only so much room for ROI in the valuation.
Now let’s look at John’s Insurance Agency. Here we have a company growing steadily and adding 500k per year. In this case the seller has more leverage in convincing the buyer that there is further upside. The company grows every year!
John is thinking to himself, “Of course, I’m not selling it for 5x last year’s earnings. We’re going to sell it for at least 5x of next year’s earnings.” But the rate of growth is slowing ($500k is a smaller percentage growth each year). So, while this is a great profile, it’s not quite rock star level.
Now let’s do this one more time.
John decides he really wants to crush this exit. Growing $500k per year didn’t quite get us there. The earnings growth on an absolute basis looks pretty, but the rate of John’s Insurance growth is actually slowing.
Enter Deililah’s Software as a Service (SaaS), Inc. Delilah’s is growing at 30% per year. So every year in our observable period, the company grows 30%. What does that do to absolute earnings? BOOM. That’s what.
In a company like this, valuation analysts are much more comfortable basing value on earnings further into the future. Sticking with a simple multiple of earnings, we’re also potentially increasing the earnings multiple. Why?
Think of this like running a discounted cash flow (DCF). In a DCF we are actually calculating the value of future earnings – not just relying on historical performance. Delilah’s is throwing off a lot more future earnings, which are worth more in today’s dollars.
Developing a company like Delilah’s is all in the execution, but if you want to exit with the highest return on your business you have to think smart growth … and that changes everything.
This article has been edited and condensed.
Dan Doran is principal of Quantive Business Valuations, a professional business valuation practice specializing in small to medium-sized closely held and family owned businesses. Dan has performed valuations for hundred of companies, and advised on a wide variety of real world M&A transactions as a partner with Clear Rock M&A. He holds the CVA credential. Connect with @Quantive1 on Twitter.
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