To maximize the value of your business, it’s critical to know what buyers of businesses want — and then make those things happen.
Most buyers desire a company with infrastructure and a management team as opposed to a one-person show.
Starting a business requires a different set of skills than growing a business. And different sets of skills are required at different stages of growth.
The skills required to grow your business to $1 million in revenue are not the same skills needed to grow your business to $10 million or $100 million. Many entrepreneurs cannot break past their early stages of growth because they aren’t able to “institutionalize” their company. Institutionalizing your company is key not only to growing your business but also to improving its value.
Institutionalizing your company involves installing systems. It accomplishes three objectives:
- It prepares your company for the next stage of growth.
- It increases the value of your company.
- It increases the salability of your company.
If you want to sell your business for the most money possible, you should institutionalize it so it can be run without you. This article tells you how.
Table of Contents
- Institutionalizing Your Business
- Building Systems
- Building a Management Team
- Building the Right Business for Your Buyer Type
- Buyer Type #1: Individual Buyers
- Buyer Type #2: Corporate Buyers
- Buyer Type #3: Financial Buyers
- Additional Factors that Buyers Consider
- Competitive Edge
Building a Sellable Business — Institutionalizing Your Business
Institutionalizing your business is usually accomplished through building systems and developing a management team.
Developing systems involves streamlining, automating, and documenting your processes. By documenting your key processes, you increase the chances of selling your business.
Benefits of building systems:
- It’s easier to attract valuable employees to your company when you have well-documented processes and clear job descriptions.
- Having well-documented processes makes managing your business easier.
- It increases the value of your company.
- It improves the chances of selling your business.
Building a Management Team
Most businesses under ten million dollars in revenue lack a formal management team. Without professional management, your business will likely die without you. How long can your business survive without you? A year? One month? Seven days?
Building a professional management team requires a new set of skills for most entrepreneurs. When you first started your business, you likely performed most of the key tasks yourself. Once you reach a certain point in your business, however, you must build a team.
Building a team requires recruiting and management skills. You have to learn how to find and hire good people, and how to get results from those people.
Determine what position or positions would add the most value to your company. What does your company need most? Do you need a CFO, COO, VP of Marketing, VP of Sales, VP of Human Resources, or should you bring in an external president? Spend time developing a formal management team. Not only will your business be easier to sell, but your revenues and profits will likely increase as well.
Building the Right (Sellable) Business for Your Buyer Type
Understand the different types of buyers and the degree to which they require systems and a management team before you invest in building systems and a management team. There are three broad types of buyers. Each has a different set of preferences regarding the type of infrastructure and systems they desire in a business. When preparing to sell your business, it’s important to understand the different buyer types, their criteria, and how you can best position your business to be as attractive as possible to these different types of buyers.
Buyer Type #1 — Individual Buyers
If your company is valued at less than five million dollars, chances are high it will be sold to an individual buyer.
- Infrastructure is not as important to them — because most individual buyers will be involved in the day-to-day operations of the business. If your business is small enough to appeal to an individual, it may not be necessary to invest a significant amount of money in building infrastructure before selling. But don’t think you’re off the hook — your business must still have enough infrastructure to ensure a smooth transition. However, these types of buyers may require less infrastructure than corporate or financial buyers.
- These buyers are also highly numbers-driven. You should prioritize profitability over building infrastructure until your EBITDA exceeds $1,000,000. If your business is valued at less than $5,000,000, it’s usually more beneficial to invest in sales and marketing to increase the revenue or profitability of your business than to invest in building infrastructure. To be sure, adding infrastructure helps. However, most individual buyers prefer more cash flow to more infrastructure.
Buyer Type #2 — Corporate Buyers
The degree to which corporate buyers require infrastructure in your business depends on if they will be integrating your business with theirs, or if they will run your business as a standalone entity post-closing.
- Integrated: Corporate buyers who will be integrating your company with theirs require less infrastructure in your business than if it is to run as a standalone business after the closing. In these cases, the buyer already has existing infrastructure and doesn’t require your business to have a significant amount of infrastructure.
- Standalone: Corporate buyers who will keep your business as a standalone entity will require significant infrastructure. They may not be interested in acquiring your business unless your company has adequate infrastructure in place and can easily continue to operate on a standalone basis without you. In many cases, this type of buyer has a manager at their corporate office who will be promoted to run your company as president. Still, your business should have a management team and systems in place to ensure that operations continue to run smoothly during the transition process.
Buyer Type #3 — Financial Buyers
Financial buyers primarily consist of private equity groups. Private equity is a relatively new asset class, and this group’s criteria are not as homogenous as those of corporate buyers. Some private equity groups specialize in lower middle-market businesses that tend to have less infrastructure. Others seek standalone entities where the owner and management team stay on for several years and where there is already significant infrastructure in place.
- These buyers’ needs for infrastructure can vary. Adding infrastructure may increase the value of your company and make it easier to sell, regardless of who the buyer is. Every buyer prefers a business that has more infrastructure to one that has less, all other factors being equal.
- Financial buyers expect to double their investment in five years before selling the business again to another financial buyer. This is often possible only with systems and infrastructure in place, and installing these systems and infrastructure costs money. If your business lacks these systems, the buyer must invest money to build them. This capital will be deducted from the purchase price of your company when calculating potential returns and the price they can afford to pay. Building infrastructure takes time and involves risk, so a multiple of this investment (two to three times) is usually deducted from the selling price when calculating the purchase price financial buyers can afford to pay.
- Most private equity firms require that management remain to run the business after the closing. Partners in private equity firms focus their time on purchasing companies and don’t become actively involved in the management of their investments. So, either existing management must remain to operate the business, or the private equity firm must hire a management team to run the business after the closing. The only exception to this rule is when the private equity firm owns a portfolio company that competes directly with yours, and they plan to integrate your business with that company.
Additional Factors that Determine if Your Business is Sellable
What follows are additional factors that buyers will look for when considering your company as an acquisition candidate. These factors must sometimes be prioritized before building systems and a management team. An understanding of these critical factors is also important when deciding which systems to implement before you put your business on the market.
The most important factor buyers look for is profitability (or EBITDA). Few buyers will be interested in your company if it isn’t taking in more money than it’s shelling out. If your business isn’t producing a profit, don’t waste your money building systems. Invest your money in sales and marketing instead. Only when your business is profitable should you invest in building infrastructure.
Many buyers will consider a profitable business that lacks infrastructure. However, few buyers will consider an unprofitable business that has significant infrastructure in place. Always prioritize profitability over infrastructure until your EBITDA reaches $1,000,000 per year.
Sophisticated buyers look for a business that is scalable, or that has the potential to quickly grow. Financial and corporate buyers love a scalable business in which the owner has not tapped its full potential. This usually involves an owner who is burned out or one who has not built effective sales and marketing systems — but one that has operational systems in place that allows the business to quickly scale once sales and marketing are ramped up. If you want to sell your business for the maximum amount possible, focus on building a business that is scalable from day one.
Corporate and financial buyers are usually in the market for a business with a competitive advantage that is sustainable and not easily replicated — individual buyers regularly purchase lifestyle businesses with no competitive edge.
An unsophisticated buyer may purchase your company if you don’t have a competitive edge, but many sophisticated buyers will not. Superior customer service is not a competitive advantage. Personal relationships are not a competitive advantage.
Your business must have a competitive differentiation that a buyer cannot easily reproduce. Otherwise, it will be difficult to sell your business to anyone other than an unsophisticated buyer. Remember, almost every company over $5 million in selling price is purchased by a sophisticated buyer.
Summary — Building a Sellable Business
Getting things done is usually accomplished through people or systems. For most small businesses, developing a management team is the most critical factor in building a sellable business. For other businesses, creating systems may create more value. There is no cookie-cutter formula.
Your business is one of your most valuable assets. Consider how you will sell your company from day one. Focus on building a profitable, scalable business with a competitive advantage that cannot be easily replicated. Focus on hiring the right people and building the right systems. By doing so, you will not only increase the value of your company, but you will likely end up making more money and increasing the quality of your life in the process.