Many business owners are intimately involved in their business. In some ways, your business can feel like a child. Too easy to only look at its potential and the good traits, too easy to brush over the negatives. There’s nothing wrong with thinking that way – believing in your own business.
But if you plan to sell your business one day, you will need to look at it like an investor would. This means looking at your business by the numbers, without the emotional attachment and dreams of future success.
It means boiling down your complex business, with all its products, services and people, to a few spreadsheets.
If you haven’t before, the first time you look at your business like an investor can be a rude awakening.
Why should I do this?
Any potential acquirer is not looking at your business in isolation. They’re looking at it as an alternative to a number of options in which to deploy their capital.
The usual alternatives would include real estate, public shares (and their various packagings, like managed funds), bonds, cash term investments, and of course, other private companies.
A sophisticated investor will be weighing up capital requirements, returns and risk when making a decision on what to invest their money in. If your business is going to be an alternative, it needs to stack up.
How an investor will look at your business
It’s always the numbers. And if it’s not the numbers, it’s the numbers. Emotion and strategy can play a part for some investors… but it still comes down to the numbers.
The simpler of a story the numbers tell, and the fewer explanations required, the better it usually looks to an investor. Yes, the soft stuff does matter1 – but to an investor that’s later in the deal.
Here are some numbers an investor is likely to look at – so you should, too.
EBITDA
While there are many ways to measure profit, the most common profit measure investors look at is EBITDA. EBITDA measures the profit generated by the business while excluding costs of tax, debt and asset maintenance. It’s a measure of the profitability of the operational business itself, rather than its funding structure or government tax policy.
Revenue
Revenue is important, although not as important as EBITDA. Revenue tells a story – is the business growing, remaining flat or shrinking? Is it lumpy or predictable? A business with growing revenue should also have growing profit.
As well as the total revenue number, an understanding of how much revenue is one-off vs recurring is valuable. Recurring revenue is looked at more favourably by investors – it’s stickier.
EBITDA %
EBITDA divided by Revenue measures how much profit is generated per dollar of revenue. When looked at over multiple years, EBITDA % shows if a business’s profitability is increasing or reducing.
Free Cash Flow
Free Cash Flow measures how much cash profit a business generates.
Some businesses generate excess cash as they grow, while others consume cash. Consider two businesses that sell the same service for the same price. Business A collects payment from customers upfront, while Business B invoices when the service is complete and collects payment after 30 days. The business that collects cash upfront has better cashflow and needs less working capital.
If both businesses were to expand, Business B would be paying higher monthly expenses – payroll, rent, etc – before having collected cash from customers.
Generating excess cash is better.
Note that FCF is different to profitability, as it considers spending cash on assets and the timing of cash, and removes non-cash items.
The most important measure
The most common way to value a business is as a multiple of EBITDA.
The multiplier is somewhat subjective, and will depend on how the investor views the quality of revenue, similar deals in your industry, the size (and therefore future longevity) of the business, the strategic value, competitive situation, etc.
Whereas EBITDA is a number that measures the quality of your business more directly. When calculated correctly, it’s a hard fact. It’s how much profit you generate. You can start tracking it now.
If you’re not regularly tracking and reviewing key financial information in your business, I’d encourage you to do so. It will help you run your business better – after all, you’re already an investor in your own business. And it will help you get a better outcome when you do eventually decide to sell.
- I’m a believer that doing the soft stuff right – culture, people, strategy – influences the numbers positively anyway. ↩︎