For most small to medium businesses, the business owner will optimise their cash vs expenses to minimise their tax spend.
This may need to change when you want to sell your business.
Generally, the sale value of your business is a multiple of your earnings.
And one type of buyer you may consider selling to is a Private Equity (PE) firm.
Since the number of businesses being sold to PE is increasing, you may want to keep this option in mind.
Back to valuations…
PE firms use EBITDA to value a business for sale.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortisation.
Why does this matter?
Business expenses are either considered “above the line”, thus impacting EBITDA: Think Operational expenses, such as salaries and cost of goods sold. More expenses here reduces your valuation.
Or “below the line”, non-operational expenses. These do not directly impact EBITDA.
A couple of interesting points about items “below the line”:
- Owning (as opposed to leasing) an asset like a car or real-estate appears here. It is regarded as a capital expenditure and depreciated over time. This is better for your business valuation.
- Consulting fees for temporary experts can be categorised here. So getting someone in on a month to month basis to help uplift your operation is not only good for your business, it’s good for your valuation. (Message me if you would like to find out more about our organisational assessment).
I found that “The Private Equity Playbook” by Adam Coffey was a great resource in understanding EBITDA and Private Equity.
In other news, this book was one of many gems I’ve picked up on Nick Bradley’s “Scale Up” podcast – check it out…
Here were my key takeaways from the book:
1. Understanding Private Equity
Private equity is about buying, fixing, and selling companies.
Firms use investors’ money to make these businesses better and sell them for profit.
2. Strategic Acquisitions
Private equity firms seek out businesses with untapped potential.
They are meticulous in their selection, focusing on companies that can be scaled and improved.
3. Value Creation
The goal is to increase the company’s value.
This can be done by cutting costs, boosting sales, and improving operations.
Making smart changes can turn a good business into a great one.
4. Leadership and Change Management
Effective leadership is crucial.
Private equity firms often bring in experienced leaders who can drive change and foster a culture of growth.
5. Exit Strategy
A well-planned exit is the endgame.
Private equity firms meticulously plan their exit strategy to sell the enhanced business at a premium.
Timing, market conditions, and identifying the right buyers are critical components.
6. Building Strong Relationships
Success in private equity hinges on relationships.
It’s about building trust with company management, employees, and potential buyers.
Strong relationships lead to smoother transactions and better outcomes.
Talk soon,
Lloyd
PS – Are you thinking of selling and want to increase the value of your business? Let’s chat.
