Maybe you’re not thinking of selling your business any time soon, but chances are you may want to some day and when that day comes I’m sure you will want to maximize the sales price.
So what are potential acquirers like private equity looking for in a business? What KPIs do they think are important drivers of value? Wouldn’t it be great to know what these KPIs are in advance so you can put in a plan to optimize them now in order to maximize your sales price in the future?
I spent some time with Jack Cacchiotti of Restivo Monacelli, LLP and asked him several questions around the topic. Jack specializes helping business owners value their businesses. Cacchiotti concentrates his efforts in assisting clients with mergers and acquisitions, as well as financing and management consulting.
There is of course a whole science and art behind valuing a company and much like real estate, your business is worth what someone will pay for it, but there are many takeaways that you can apply now.
SO what are the top 6 KPIs (key performance indicators) you should be tracking to maximize the value of your business?
1. Good externally prepared financials
The first KPI is really not a KPI at all, but the foundation that must be in place in order to measure the KPIs correctly. According to Cacchiotti, “good external financials show the potential acquirer that you are serious and organized, increasing the perceived value of your business”. This is similar to the real estate agent that asks you to make minor repairs and even asks you to “stage” your home, remove clutter and maybe give each room a fresh coat of paint. Externally prepared financials shows that someone other than yourself has validated the numbers outside of just your tax return. There may even be things that firms like Jack’s can do to clean up your financials.
2. Analysis of your G&A as a % of Total Revenue
As a small business you may be running several personal expenses through your business, in effect increasing the perceived G&A (general and administrative) expenses. According to Jack, this type of behavior “increases anxiety” in a buyer. Properly accounting for these expenses as distributions shows a potential acquirer that you are disciplined.
Running these expenses through the P&L can also mute your ability to assess the true health of your business. Is your business operating efficiently? Companies like ProfitCents offer benchmarking which allow you to compare your G&A costs to best in class.
3. Average revenue per customer
I would classify this KPI under the category of “revenue risk”. If 90% of your revenue is concentrated with 2-3 of your customers, there is a huge risk to your business if one of those customers were to defect. If you’re looking to sell in 3-5 years, look for ways to reduce this risk and increase value. One approach is to analyze your profitability by customer. That one big customer may be bringing in a lot of revenue, but they may also be much less profitable. Consider how many smaller customers it would take to replace the one big customer from a profit perspective.
4. Customer Satisfaction / Customer Churn
Similar to revenue concentration and the risk to the business is customer satisfaction. How happy are your customers? How do you know? What is your process for measuring their happiness? What are the renewal rates? These KPIs give you a sense of the stability of your company’s revenue. This is also why companies with recurring revenue and low churn typically have higher valuations than “one time” customer businesses.
5. Gross Margin
Gross margin is an essentially a measure of how efficient your business model is. If you sell $100 worth of goods, what does is cost to provide those goods? Obviously, if it costs you more to provide the goods than you sell them for, you don’t have a viable business. You want to minimize your COGS or costs of goods sold. The higher the gross margin of your business, the more efficient the business model. If you sell multiple products, you should know the GM of each of those products. You might even consider dropping one product whose gross margin is too low.
6. Employee Churn
Tracking your employee churn and working to improve employee retention can be a huge money saver for your business. Here is the cost to replace an employee according to a CAP study:
- Low-paying jobs, high-turnover jobs (earning under $30,000 a year) can cost approximately 16% of annual salary or $4,800.
- Mid-range positions (earning $30,000 to $50,000 a year) can cost approximately 20% of the annual salary or $6000-$10,000.
- Highly educated executive positions ($100,000+) can cost up to 213% of the annual salary or $213,000!
You can see how tracking employee churn and keeping it low is a key driver of company value.
Once you’ve determined the KPIs which are key drivers of company value, develop a monthly meeting rhythm to track them and make sure they are moving in the right direction. You can develop some strategies or action plans aimed at improving the weaker KPIs. For example, if your customer satisfaction is poor, you can dive deeper into the issue to determine the root cause and fix it before selling.
Any buyer is going to find out all your business’ weaknesses and try to reduce the sales price based on those weaknesses. It’s better to know what’s wrong in advance and put a plan in place to fix it. It will cost you much less in the long run and will drive the value of your company much higher.
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