Cultivating Goodwill in Your Business's Sale Price
Let’s clarify “goodwill” for a moment. First, we’re not talking about the behemoth thrift store you can find in almost every city in the nation. Instead, we’re diving into the world of intangible assets when it comes to determining the value of your company.
Recently, I wrote that one of the shortcomings of an independent valuation boiled down to inability to factor in the “intangibles” of a business. If it were as simple as evaluating inventory and assigning value to equipment, there’d be no need for a business broker. Also, you would basically be liquidating the company.
But you and I both know that your business holds more value than the basic assets. If that weren’t the case, any Tom, Dick, or Harry could build what you’ve created just by investing into equipment and personnel. There’s magic behind the curtain which converts a team, equipment, and inventory into a thriving business.
That’s what we call “goodwill.” At Exit Consulting, we define goodwill as all the intangibles, such as brand recognition, perception, systems automation, intellectual property, and all the perceived value that a new owner could inherit when they take the lead.
Translating Goodwill from Owner to Owner
The first question a prospective buyer will ask is, “How much of this achieved goodwill will transfer to me?” It’s a fair question, as many times owners build a high percentage of their goodwill around them personally, not the business as a unit. This can be translated to the owner being the key salesman, the sole individual who knows the processes or assumes the role of owner and middle management.
Let’s take a company called John Ovrom Consulting. Once I, John Ovrom, leave that building, what confidence can a client have that Susie Smith will provide the same service earned directly by John?
If you have your name on the building, this is your wake-up call. It’s essential to rebrand now so that you can build value into a name that doesn’t become obsolete once you walk out the building. Even if your name isn’t plastered all over the building, take time to think about how much of the business depends on your unique skillset or understanding of the secret sauce.
The more the success of the business depends solely on your involvement, the less a buyer will feel they can step in and run it. Perceived risk from the buyer devalues the intangible value of goodwill. Since goodwill is subjective, the key to maximizing the value of goodwill is ability of the buyer to keep it upon your departure. If the goodwill is based upon the owner, then when the business sells the goodwill goes with the seller.
Intangibles Vary By Industry
Goodwill transfers better in different industries. While many factors play into the equation, market density and competition can play a big role. For example, let’s take two medical businesses making $2 million in revenues. Typically, you take revenues and add a multiplier to factor into the sales price. That multiplier varies based on how the goodwill transfers in specific industries.
Let’s start with a dentistry practice looking to trade hands. Statistically speaking, 40% of patients leave when you trade out dentists. That’s a high turnover, which means that an incoming dentist will take a dive on revenues, and need to ramp up marketing in order to replace clients. In short, there’s a dentist on every corner, even in a market as small as Coronado.
Then we compare a veterinary practice in the same market. Statistically, veterinary practices experience a low turnover after the sale. Part of that is because specialists are more rare. Due to smaller turnover, we can sell a veterinary practice making $2 million in revenue more than a dentistry making the same.
Now let’s throw a curveball into the equation. Veterinary practices have stipulations to their multipliers. If a company is making less than $2 million, say $1.5 million, you’re looking at 80% (.08 multiplier) of revenues. But once it hits that magical $2 million revenue mark, all of a sudden the multiplier jumps to a 1.5 multiplier. That’s because the $2 million mark is the threshold where larger businesses start looking to make a play and buy up your practice.
Market Trends and Market Shares
If you’re in the cyber security space right now, you should be killing it. These businesses are in high demand, short supply, and the need is dramatically increasing.
Then compare that industry to the newspaper world. You just cringed right? That’s because we all know print is a dying medium. It just keeps limping along, refusing to completely go under.
Industry strength matters, as does how much of the market you control.
A thriving business with skyrocketing profits that only controls 1% of the market poses a risk. A gorilla company, such as Amazon or Netflix, can come in and wipe you out. You’ll fall faster than Blockbuster.
Speaking of Amazon, that brings us to the complexity of online businesses. What digital real estate do you own, and what percentage depends on one of the other platforms, in essence rented land with no set contract?
Sell 90% of your products on Amazon? Great, but what happens if your rankings falter. Bye-bye profits. The same goes for companies driving the majority of their revenue from different social platforms or organic searches. One algorithm change and your business is toast.
It might not even be the algorithm change. Just ask any business who sells food products on Amazon. A huge earthquake just shook the foundation of their business as Amazon bid on Whole Foods. Companies in the food space, such as Blue Apron who don’t even sell on Amazon, also faltered as they found themselves directly in Amazon’s path toward world domination.
Personnel and Leadership Organization
The transition between owners needs to be seamless. While implementation of automated systems can control a lot of that process, the role of team members comes under the spotlight. Ultimately, they will be the support system during the exchange, as well as the foundation for future growth.
Here we need to ensure that key team members will weather the transition. If your CFO plans on retiring the day you head out, there’s going to be a huge problem for an incoming owner. We also need to prepare for some of the anticipated turnover through refining job descriptions, outlining duties, and writing out exact processes that make the business hum along.
Driving Value Before the Sale
One of the main focuses of our consulting team is to create ways for businesses to drive value before going to market. We go through your business with a fine-tooth comb to identify opportunities to strengthen goodwill value, reduce risk, stabilize revenues, implement systems, and more to reduce perceived risk for a prospective buyer.
After all, the more you can make your company appear to be a sure bet, the better you’ll do.
If you are thinking of selling or exiting your business in the next one to three years, contact us today. While the timeline varies, most times it takes one to two years to fully implement these strategies well, increasing the value of your company.