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September 20, 2022

Three Biggest Mistakes Business Owners Make that Lower Company Value

It’s not uncommon for business owners to have the majority of their net worth tied up in their ownership of a private company, which makes them highly dependent on the successful sale of the business to provide the cash they need for retirement. To maximize the potential price in a sale of the business, it’s important to avoid the following common mistakes that could cost you.

Focusing Too Much on Minimizing Taxes

Not surprisingly and, to some degree, understandably, many owners operate their companies to minimize income taxes. However, this may not be the best practice if you ultimately want to sell your business at the highest possible price.

Minimizing taxes while also preserving the true profitability of the company makes business sense. Alternatively, minimizing taxes by artificially lowering profits, for example, running personal expenses through the business, can cost an owner tremendously in a sale. To minimize taxes, many owners operate their companies as “lifestyle businesses,” which means the owner takes as much money as possible out of the business to fund his or her lifestyle and minimize the tax burden. Unfortunately, money taken out of the business along the way is rarely saved for future needs. To maximize value for a sale, the focus throughout the business’ life cycle should be on treating the business like an investment.

Focusing on Revenue Rather than Margins

While growth in revenue is important, an owner cannot ignore profit margins in the process. Doing so can decrease the value of a business. Companies that sacrifice margins to keep revenue high face a risk of reducing overall profitability and, in turn, company value and position in the marketplace. One strategy to increase margins is to add recurring revenue to the business, such as:

  • Agreements – for service or maintenance
  • Customer contracts – for consumable products or replacement parts
  • Subscriptions – for products, services, or information
  • Memberships – with package options

Recurring revenue is virtually guaranteed revenue, at least for some period of time. Key benefits of a recurring revenue stream include:

  • Does not require the same level of sales and owner effort as one-time revenue
  • Often has higher margins
  • Is highly coveted by buyers
  • Businesses with recurring revenue tend to sell at higher multiples than those that don’t

Being Too Dependent on the Current Owner

One of the biggest concerns buyers frequently have involves a business’ degree of dependence on the current owner. Too much dependence on the current owner not only causes a business to be less attractive to a buyer, but also create greater risk for the current owner.

The question to ask is: How would the business continue to function and prosper without the owner?

All too often, the current owner has the key business and customer relationships, processes, procedures and technical know-how all under his or her control. In extreme cases, the owner “is” the business and too much of the value is tied to, and cannot be separated from, the current owner. This is the exact opposite of what appeals to a buyer. The more autonomously the core parts of the business can operate without significant direct involvement from the current owner, the more appealing the business will often be to a buyer.

How to Course Correct for Lost Value

If you’re a business owner contemplating a sale at some point in the future, do any of the above examples apply to your business? If so, now is the time to act. You need to determine how to address and rectify these issues as quickly as possible. Doing so may pay dividends in ensuring you get the most for your business in a sale. Anders has Forensic, Valuation and Litigation advisors to help understand and increase the true value of the business and Business Transition Planning advisors to help plan your transition in line with business and personal goals. Learn more about how to begin the business valuation process or contact an Anders advisor below to discuss your specific situation.

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