This is part two of a series on the differences between selling a house and selling a business. This is an abstract from a Whitepaper on this subject available upon request from the author at: [email protected].

In part one, we discussed some of the key drivers and the effects that improvements have on home value. Now, let’s drill down into the effects that improvements in a business can have on transaction value.

There is some interesting research recently done on owners who have actually received written offers for their companies by “Built to Sell” a firm dedicated to helping business advisors understand the dynamics of business ownership changes for privately held companies. The figures below illustrate some of the macro differences. Not surprisingly, the most recent data indicates that there are market valuation differences between industries, size of business, and market timing.

Apart from personal and market considerations, for an owner to enter into an optimum sale process there are three important business timing considerations: Company Growth Opportunities, Financial Performance and Risk. Few, if any, buyers are motivated by lifestyle elements such as funding a country club membership, financing exotic vacations, luxury vehicles, a vacation home, etc. With the purchase of a business, the buyer’s needs are based mostly on its recent financial performance and the cost of capital to achieve a targeted investment return.

Growth considerations include: business strategy, marketing, market share, brand recognition, customer loyalty, and scalability of the business. The financial considerations look at operating margins, efficiency, Capital Expenditures and the order-to-cash operating procedures that impact quality, product delivery and cycle time. Finally, and perhaps the one most sellers don’t appreciate, is the inherent risks in the business including the bench strength of the management team, customer/supplier concentration, intellectual property and competitive advantage. Offers to purchase a company are inextricably tied to all these elements.

Some valuation models measure as many as eight categories, and 6-8 subcategories for each as part of the risk assessment for a business investment. Financial models account for this risk through the cost of capital required that generates future cash flows and the needed returns on the investment to make it attractive.

To illustrate the impact of the various factors contained in one of these models, we segmented the value drivers and compared performance levels of a hypothetical “Average Company” to one that was considered to have all the “High Value” characteristics. (A breakdown of the major categories, subcategories and performance levels is available in the complete whitepaper.)

To separate out the impact of these specific factors from those that are, by and large uncontrollable by an owner, we looked at how the above differences would impact the value of a company in the same industry (manufacturing), same size ($10 -$20 Million in annual sales) and valued over the same time period i.e. last eight quarters (Q3’12 – Q2’14). The model generated a combined score for each company type, which was then correlated with the actual written offers received by similar companies over this period to create a current market value for both. Our analysis found that the average company with normal risk, generating about $15 Million in sales and 5% operating margin, has a current market value between $2.9 – 3.9 Million. However, it also has the opportunity to garner up to $5.2 million more value by focusing on the subcomponents identified in each of the three categories. (Specific details are available for review in the whitepaper.)

Figure 1: Contributions to Value Improvement

Even more interesting is that each of those characteristics is largely independent of the value impact of the other. In other words, if one or two areas are not improved, the value opportunities in those that can be improved will still contribute (perhaps significantly) to value enhancement. (Note that while these Value Improvements apply to the space and size we have chosen, other industries and size categories will show similar differences.)

Unfortunately, unlike selling your house, data on the payback of presale enhancements for a business does not exist, since there is no published information on the cost to achieve these kinds of improvements. Each is a function of skilled specialists, trained to understand how to achieve the higher level of growth, financial performance and reduced risk inherent in a business.

However, it is highly likely that the ROI of these efforts will be significant (up to 10X) both in terms of return and time to secure an attractive offer. Each situation is different and there are many moving parts which make the process difficult to generalize. On the other hand, experienced advisors should be able to provide good ROI and payback information for their services. (Some will even work for a small retainer and a contingent upside.) But keep in mind, its not what YOU put into the business, its what a BUYER can get out of it that matters. The better a business performs without risk, the more a buyer can afford to pay.

So what’s the take-away from all this? There are some significant differences between getting your house and your business ready for sale. Just because market conditions may be favorable doesn’t necessarily mean the timing is right for the business or the seller. The improvements needed to sell a business aren’t like putting a new coat of paint on a wall or updating a kitchen. They are not ones that can be achieved over a 1-2 month period. They will likely take 2-3 years to get the desired result, but the ROI is way more than compelling.

A business that is truly ready can fetch a significant premium with the right market conditions. But if an owner is not ready, “Forget about it!” Many a wasted effort has been expended in a busted sale process due to a flaw in one of the elements described above but none more than with an owner who is not really hard-wired to sell. The good news is that getting a business in position for a sale will yield unconditional benefits. The sooner you get started, the sooner you will be able to either initiate a sale process, achieve better annual dividends, or respond favorably to an unsolicited offer if it presents itself. It was Henry L. Hartman who said, "Success always comes when preparation meets opportunity.” Nothing could be more fitting than in selling or buying a business.