Succession Planning — how to double your exit value…

The owners of most small-medium sized enterprises at some point seek to bring on external investors (often private equity) or sell. Often, this is as the original, older generation looks to move on, maybe because of changes in personal circumstances. Or, perhaps due to competitive pressures during industry consolidation or model change, and challenges that need new hands on deck.

A typical mistake often made by business owners is to extract too much from their businesses over the years. The thinking goes that if one reduces the profitability of a business, then less corporation tax will be due. Owners and their families want a better lifestyle, and not leave much profit in the business for the longer term. Many SMEs and family businesses maximise deductions and distributions. In countries such as Australia, owners often set up elaborate family trusts to pay income into, reducing the tax burden on the beneficiaries, and in so doing make their business dealings more opaque.

When one looks to attract private equity investors, trade acquirers or list, the main metric used to value a trading business is the price to earnings (P/E) ratio. Depending on sector, trends, growth trajectory of a business or its sector, this ratio may typically be anywhere from 5 to 20 times.

Ie a business with profit (usually EBIT, earnings before interest and tax — a rough proxy for cash generation) of say £1m per year (pa) will be £5m at a 5x P/E multiple.

If that business could have been making £2m pa, but its owners reduced its profitability intentionally, then the business which could have attracted a £10m valuation, will be worth half — only £5m!

In order to maximise that (exit) value, owners need to maintain profitability over a period of time, and not just immediately pre-exit. They should also consider simple structures and how to embrace good governance, simple structures and transparency. This attracts investors or acquirers.

qodeo — http://www.qodeo.com/ — tracks over 1,500 Venture Capital and Private Equity firms and 14,000 entrepreneurial businesses globally, many of whom are later stage, seeking ways to raise development capital or divest. EBIT is a key metric for matching scaling businesses with PE funders in our new service. Start focusing now on the bottom line today to benefit from an increased future valuation!