Canada is experiencing a wave of business ownership transitions. Nearly one in 10 businesses are expected to come up for sale outside the family or management in the next five years. That means nearly 120,000 companies are expected to change hands in Canada.
The transition wave is being fuelled by retiring baby boomers and a post-pandemic shake-up in the business landscape.
At BDC, we often hear from entrepreneurs thinking of selling their business. Their first question is typically: How much is my company worth? They usually follow up by asking how to improve that number.
It can be a sensitive conversation. A business—and its value—often represent the life’s work of the owner. It’s their baby—and selling it is the biggest transaction of their life. The amount entrepreneurs get upon exiting their business is very often their retirement fund.
Overly optimistic expectations are common
For these reasons, it’s not unusual for business owners to have overly optimistic expectations about what their company could sell for. It’s common for entrepreneurs to hear about another business they feel is similar to theirs and assume their own company is worth the same amount.
In fact, business valuation and the price a company realizes on sale are influenced by numerous factors. These could include:
- industry trends and risks, including regulatory and geopolitical climate
- sustainability of cash flow growth prospects
- quality and sophistication of financial reporting and planning
- quality and strength of systems and governance
- how integral the owner is to operations
- state of equipment and required investment
- market conditions and the regulatory environment
It’s also important to keep in mind that valuation can be done using several different methods. In many cases, an earnings-based method is appropriate. Where a company’s historic operations are not expected to change significantly, a multiple is typically applied to historic cash flows to determine value.
In cases where the business has pivoted and future operations will be different, an approach that utilizes future cash flows could be appropriate. Software companies tend to be valued using multiples of recurring revenue. In other cases, a company’s assets are a better indicator of its value (i.e. a real estate holding company).
You can see how easy it is to get an inaccurate idea of what a buyer may pay for your company. Because of the complexity, it may be useful to hire a chartered business valuator.
3 steps to boost your valuation
It’s also important to realize that your company’s valuation isn’t written in stone. It can change depending on your business prospects and market conditions. Entrepreneurs should always remember buyers pay for cash flow—historic or future.
You can improve your company’s value by taking steps to make your company more attractive to buyers. Here are three key things you can do:
- Improve your results —Look at your income statement line by line to see how you can improve on each element. This may include increasing product margins, adjusting your pricing strategy or doing an operational efficiency exercise.
- Ensure you can walk away—Your company should be able to smoothly transition to operating without you. Delegate tasks to empowered key employees, and make sure processes are sustainable, repeatable and well documented.
- Solidify reporting—Your financial statements, forecasts and management reports (e.g. KPIs, equipment maintenance reports) should be reliable, accurate and timely. Consider getting outside advice if they’re not.
A final piece of advice: Don’t wait to make improvements. It can take three to five years for changes to show results. Buyers typically look for two or three years of improved financial performance to see that changes are sustainable.
Taking steps now to understand what determines your company’s valuation—and making sure you maximize it—will help ensure you get the best possible price for the business you put so much effort into building.
Laura-Lee Brenneman is Business Centre Manager of BDC’s Ottawa West office.
