Valuing your service business
By Alex Shteriev
By Alex Shteriev
The value of a business depends on what the market is willing to pay for it at any given time. Values depend on the industry, buyer interest and willingness to transact, and the state of the economy.
Knowing the value of a business as well as understanding what factors make it valuable can help owners focus on the right things when running a business. Even if you are not planning to sell, bringing in employees as partners or investors at any given time is only possible if they understand what the business value is at that time.
Additionally, even if you are planning to pass the business on to your children or family member, you need to have an arm’s length business valuation done.
At the current moment, the market is valuing businesses within the Water Service Industry at the following earnings before interest, tax, depreciation and amortization (otherwise known as EBITDA) multiples: revenue $0-$500,000 (1.79x); revenue of $500,000-$1,000,000 (2.69x); and revenue of $1,000,000-$1,500,000 (3.92x).
By taking an annual amount of maintainable EBITDA and multiplying it by the Enterprise Value/EBITDA multiple, one can attain a rough estimate of the business enterprise value. While this estimate of value is generally inclusive of certain balance sheet items, it does not take into account adjustments necessary for excess working capital, redundant assets and other circumstances.
Some service industry businesses have difficulty maximizing their value due to the nature of the work they do. Multiples could be negatively impacted by unpredictable workflow, fluctuating profit margins and the uncertainty of future business. Key areas of improvement that are pertinent to service businesses are growth potential, recurring revenue streams and owner reliance. Improving these areas can go a long way in increasing value and sellability.
Contractors should focus on finding a way to carve out a niche within their industry. By doing so, competition is reduced as you are not competing directly with others in the marketplace and can differentiate your services. A niche allows for the market to be defined, creating greater certainty of financial performance and growth potential, and reducing the perceived risk of the business.
Due to the nature of the work performed by service industry professionals such as water-well contractors, it is difficult to project where the next dollar of income is coming from. Introducing a recurring revenue stream into the business model is comforting to a buyer as it allows them to see future revenues that will be realized upon a change in ownership.
Creating a business that does not need to be started from scratch each month will increase the value to buyer and maximize a sale price. An example would be a well-drilling contractor taking over the maintenance and inspection needs for the well for a recurring monthly or annual fee.
The reliance on a single owner depresses the value that can be extracted from a business. If a business is dependent on a single owner, it decreases the sellability of the business. Establishing a management structure and human resource organization that is not completely dependent on the owner is important in maximizing the business’s value. Also, the ability to have a seamless transition upon the sale will increase the value and likelihood of successful sale.
Alex Shteriev is managing director at Beacon Corporation, an M&A advisory firm that specializes in the sale of small to medium-size Canadian businesses. Headquartered in Toronto, Beacon has offices throughout southern Ontario and transacts businesses across Canada.