The 8 Components of the Sellability Score

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Eight ComponentsWe’ve reviewed John Warrilow’s book Built to Sell in our book club series and many of our case studies are taken from accounts shared on his Built to Sell podcast. In many of those interviews John goes over the same ground with business owners as they share their stories of building, growing, and exiting. Over time, John has developed a “sellability score” that we think captures some key metrics all potential sellers should take note of.

Financial performance

This metric is about your history of producing revenue and profit as well as how consistently and professionally your books have been prepared. In a certain sense, every business transaction starts here and it’s something we can never say enough about: pay your taxes and keep accurate financial records.

Growth Potential

If someone were to come into your business as a new owner, what rate of growth could he/she expect with regular effort? With nights + weekends effort? This can be gleaned not just from the trends your financials show, but products/services you have not yet implemented for various reasons. Could the business expand geographically? Could new customers be created from unused capacity?

Switzerland Structure

For Switzerland to have been neutral for centuries, it has had to learn to be very self-sufficient. Neutrality may keep you out of conflicts but sometimes it isolates you as well. So too with your business and dependence on a single customer. A general rule is that no more than 15% of your company’s revenue should come from a single customer. The more diversified your revenues are, the more attractive your business is to buyers.

Value Teeter-Totter

Can your business finance its growth from its own cash flow or does it need to rely on outside capital? A buyer will pay more for a company that has less need for outside financing, and will pay less for a company that has more need for it (hence the “teeter-totter”). Two quick ways to make adjustments here would be to reduce your collection times from your customers and increase your payment times to your vendors.  

Recurring Revenue

Do you have recurring revenue? Is it in the term of subscriptions or long-term contracts? What is your churn/cancel rate? The clearer your answers to these questions, the more a buyer can be assured of some “guaranteed” revenue.

Monopoly Control

How well are you differentiated from your competitors? The greater your competitive advantage, the likelier you are playing in a blue ocean, in which you define the rules your competitors play by. The more differentiated a business is, the more valuable it is to an acquirer.

Customer Satisfaction

In a previous article we discussed Fred Reichheld’s Net Promoter Score and how it could help you better understand how happy your customers are. In a certain sense, customer “satisfaction” is simply a baseline. You want them not just to be happy with what you’ve delivered, but happy enough to share your company with others.

Hub and Spoke

What does your management team look like? If you were incapacitated or unable to work for a period of weeks or months, how would your company perform? Employees that can be counted on are a major driver of confidence (and value) for potential buyers.

These factors are not a definitive list of key things a business owner should look at before considering a sale, but they are a very good list. And one that, if seriously attended to, will make a business incalculably better. Even if selling is not on the immediate horizon.  

Unhappy about how any of these components in your business at the moment? Give us a call so we can help you improve and get on the path to a possible exit.

4 Financial Ratios to Better Understand Your Business

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Financial RatiosSome business owners confine their working knowledge of finances to what’s in the bank today vs. what needs to be paid today. Others will give a quick glance at monthly financial statements their bookkeepers have given them. But the most savvy business owners take those financial statements and examine some simple financial ratios in order to keep tabs on and improve their small businesses. These ratios should be compared to industry standards. (Don’t worry, there won’t be a test at the end!)

Quick Ratio

Also known as the acid test, the quick ratio is a way to understand how much money you have to deal with your current liabilities. It’s calculated by taking your current assets (excluding inventory, which is not quickly convertible to cash) and dividing it by your current liabilities. 

A ratio of 1.0 is acceptable, but it means that you have only $1 of cash on hand to deal with each $1 of liabilities. Anything north of 1.0 means that you have at least a bit of cushion in case of a cash crunch.

Gross Profit Margin

This is often considered a “tell-all” metric and is something that should be monitored month-to-month and year-to-year as you want it to stay consistent. You calculate GPM by taking your gross profit (total revenues minus costs of goods sold – COGS) by your gross revenues.  

What the margin is will depend on what kind of business you have. If you are selling a premium product, you typically see a higher margin, whereas if you are competing on cost, a low margin is more likely. As we said, it’s a number that should stay consistent so if your margin goes down it could indicate:

  • Your costs have increased but you have not increased pricing to match
  • You have a problem with shrinkage/unauthorized free giveaways

Net Profit Margin

This is a more granular version of the Gross Profit calculation. In the numerator, you will take total revenue and subtract COGS, but this time also take out operating expenses to arrive at net profit. Divide that by total revenue and you get your net profit margin.  

If you’re unhappy with the number, there are a few remedies:

  • Raise prices
  • Decrease COGS
  • Review your operating costs. Can you improve business productivity?
  • Analyze your sales mix – is it diversified enough?

Average Customer Sale 

If the previous three ratios examined your business at a macro level, this ratio examines it on a micro level by looking at each transaction with a customer. It is calculated by taking the total amount of sales divided by your number of customers. This number will allow you to identify what each customer is spending with you, on average. If this number is much lower than you expect, then there might be missed opportunities for add-on sales or associated products/services at the point of sale. If it’s much higher than you expect, it’s a great opportunity for you to see what is going right and lean into it!

There are a select group of people who live for numbers, but we know that most business owners don’t. If you need some help with these ratios, give us a call so we can help you better understand your business!

Book Club #20: The Lifestyle Business Owner, by Aaron Muller

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Lifestyle BusinessThe subtitle of Aaron Muller’s book is “How to Buy a Business, Grow Your Profits, and Make it Run Without You.” While entrepreneurship has perhaps never been more in the public consciousness, the phrase “lifestyle business” is still not commonly known in the general public, and this book goes a long way to addressing that gap while sharing some important lessons along the way.

Let Your Business Be Your Business

For those who are considering buying a business, there’s often some soul-searching: is this my passion? Muller’s response to that query is one we tend to agree with: “Finding meaning and purpose in your life is hard enough. Finding a profitable business that also gives your life the unique meaning and purpose you are looking for is doubly hard.”

It’s a lot to ask of a business to offer meaning and purpose for your life. Rather, you should focus on:

  • Soundness of the business.  Are the taxes and paperwork in order? Are the financials up to date and do they show promising trends?
  • Role in the business.  Are you being asked to be an owner-operator (someone working on the business each day or at least each week) or an absentee owner (someone who only periodically checks in on the business or if there is a major decision to be made)? Do you think this role would suit your talents and current desire to work?
  • Growth potential.  Is this something that you can build on in the next 3-5 years to give yourself more options, i.e. build from owner-operator to absentee or from absentee to another exit.

Leverage Previous Mistakes

In a previous article we shared that a buyer of a business was able to more than double his income simply because he fulfilled the orders that the previous owner failed to do. The author shared a story about a business he once bought which had alienated many customers: “In fact, I even put up a banner on the building that read, “New Owner. Friendly Service.” Within one year, revenues increased by over 65 percent.”

Sometimes previous owners have made mistakes they haven’t told you about just because it’s too personally embarrassing. One of them might include poor attitudes with clients or times they simply could have done better on the customer service side of things. Never underestimate the power of a restart and the second chance a customer might give to a new owner.

Bring Your ‘A’ Game… and Teach It

“Whatever it is that is causing your customers to come, you need to transfer that skill to your employee,” Muller opines. He’s right. Whenever you are able to bottle your value-adds into training and company manuals, you’ve created a better asset for a future customer.  

At the heart of a lifestyle business is the unique proposition of creating a schedule you determine and an income you’re responsible for. Don’t be beholden to a 9-5 office paradigm. You can work the hours you want on the days that you want… as long as you set up the proper systems to do so. While the lifestyle you build for yourself may limit scalability and growth for your company, this will be a conscious choice you make that will also make the business an attractive acquisition for someone in the future, who like you, wants a lifestyle business.

We offer businesses of all “speeds” here at Apex, including lifestyle businesses.  Learn more today!

2020, Elections, and Capital Gains Taxes

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PoliticsThe new year is upon us, and it happens to be an election year. While the ups and downs of politics may seem to be, at first glance, unrelated to the buying and selling of businesses, the 2020 election promises two different visions for the country in relation to taxes and wealth. That said, it’s always smart to think ahead when it comes to tax consequences for selling a business, so let’s take a moment to examine a few ideas.

Capital Gains Tax

The capital gains tax is assessed on the increase in value between the cost basis of an asset and its eventual sale price. Long-term and short-term capital gains carry different tax rates and are classified based on whether an asset has been held for more or less than one year. The federal long-term rates are currently 0%, 15%, or 20%, depending on your tax bracket.

Taxes in an Exit

TaxesThose who have not sold a business before are frequently under the impression that almost all of the proceeds from the sale will be taxed at the long-term capital gains rate, but that’s not necessarily true. Many business owners are surprised by “depreciation recapture” that is taxed at ordinary income rates. The allocation of the purchase price between hard assets, goodwill, and other asset categories will be part of negotiations between buyer and seller and will have tax implications for both parties. An entity’s legal structure may also impact taxes. What’s good for the seller tax-wise is often bad for the buyer (and vice versa) so these points are often traded during negotiations.  

Time to Sell?

Whatever your political principles or betting tendencies for the 2020 election, it’s important to note that capital gains, like any tax policy, is a frequently targeted item. In 2003, President George W. Bush reduced capital gains to 15%. In 2013, President Obama raised capital gains to 20% for those making more than $400k annually. It was expected that President Trump might push for some capital gains cuts, but no progress on that so far.

We certainly did see a surge in sellers in 2012 as they anticipated an upcoming increase in the capital gains rate. And if you think there might be a change in presidency, many of the opposing candidates are on the record supporting an increase in taxes across the board, including in capital gains. While the election is at the end of 2020, and any legislation will need time and a willing congress to pass, it’s important to think about the tax impact of a sale sooner rather than later, in advance rather than in a panic. The exit is the most important financial decision you will make in building your business, so it’s important to work closely with an accounting professional to consider and plan your tax strategy and how you will structure that into the transaction.

Not sure what your tax consequences will be from a sale?  We can put you in touch with specialists who can help you decipher that.  Give us a call today.