The Secret to Making Your Business Saleable

Last Updated Jul 29, 2010 3:51 PM EDT

If you're a business owner and you're still doing all of the selling yourself, your company may not be worth as much as you think.

Let me explain.

I used to own a five-person advertising agency. I did the selling, and my employees did the work. We squeezed out $150,000 in pre-tax profit from $750,000 in revenue designing brochures and websites.

Curious to see what my business might be worth, I started to investigate how advertising agencies were being valued. I found at the time they were trading for 18 to 22 times earnings before interest, taxes, depreciation and amortization (EBITDA) by the stock market. I did the math and figured, using the 18- to 22-times multiple, my $150,000 in pre-tax profit could equate to a business worth $3 million or more.

Excited by the prospect of a multi-million dollar payday, I asked around at our industry trade show and heard that small marketing agencies were selling for about four times pre-tax profit. I was disappointed to learn smaller agencies sold at such a steep discount but was still relatively happy to know that my little five-person shop was worth more than half a million dollars.

In fact, I started to think of the $600,000 my agency was worth (using a four-times multiple) as if it were a relatively liquid asset like my home or mutual funds investments.

I remember well the meeting that finally burst my bubble. I was sitting at a boardroom table across from two partners in a 60-employee advertising business that generated around $10 million in sales. I was pitching the partners on investing a little cash and expertise in my company.

I had prepared for the meeting with PowerPoint slides describing the future I saw for my agency. I had projections, spreadsheets -- I was prepared for their questions. As I got ready to ask them to invest, one of the partners interrupted: "We wouldn't buy equity in your business at any price. Your business is really not worth anything right now."

I felt as if I'd been sucker-punched. I could feel the irritation rising up inside of me, and the adrenaline pushed away any opportunity for rational thought.

Angry now, I responded, with as much authority as I could muster, "Small agencies sell for four to five times. My business is worth at least $600,000."

"Well, it's not worth that to us."

The problem? In short, me. What I would later learn is that acquirers place a steep discount, often to zero, on very small businesses in which the owner is doing most of the selling. In the absence of any more objective measure, acquirers often do a quick valuation test by looking at the size of the company and how involved the owner is in the selling. By doing all of the selling, I was actually bringing the value of my company down. Acquirers reason that a very small business is probably highly dependent on the owner, whereas a larger business got big by figuring out how to get other people to do much of the selling.

How do you avoid this small-company discount to zero? It depends on the buyer. Some acquirers look for a company with at least $5 million in sales; others look for at least $1 million in earnings before tax; others have no hard number but use soft measures to see how dependent the revenue is on the owner personally.

After recovering from that fateful meeting, I focused on hiring salespeople so that we would grow larger and I could legitimately make a case that other people were doing the selling.

For Sale photo courtesy of Flickr/Ian Muttoo

  • John Warrillow

    John Warrillow is the author of Built to Sell: Turn Your Business into One You Can Sell. He has started and exited four companies. Most recently, he transformed Warrillow & Co. from a boutique consultancy into a recurring revenue model subscription business, which was acquired by The Corporate Executive Board. Watch this video to hear John's thoughts on starting and growing a business you can sell.

    John and his book "Built to Sell" have been featured in CNN, MSNBC, Time magazine and ABC News. John was recognized by BtoB Magazine's "Who's Who" list as one of America's most influential business-to-business marketers.

    John now divides his time between homes in Toronto, Canada, and Aix-en-Provence, France. He is a husband and father of two rambunctious boys.