Based solely on this information, the right answer is Company 2, because it works half as hard to generate the same amount of profit.
Profitability is the primary driver of a company’s value. The profit generated by the business is what the buyer gets to put in their pocket. A business that generates no profit is typically not worth much (excluding some very large companies like Amazon and Tesla). Generating revenue is a part of the story, but generating profitable revenue is really the key.
Start by looking at your various offerings (products, services, etc.) and determine which ones generate the best Gross Profit and Gross Margin (defined as: Revenue – Direct Costs = Gross Profit / Revenue = Gross Margin).
Then figure out which types of customers are the most profitable (read about why it’s important to know who your best customers are here). By focusing in on high-margin offerings and high-margin customers, you will find sweet spots for your business. Direct 80% of your marketing and sales efforts on increasing revenue coming from your sweet spots.
The “profit story” is also important for increasing the value of your business. Even if your revenue is not rapidly growing, a trend of healthy revenue growth coupled with improving profitability percentages can have a dramatic impact on the value of your business.
Lever #3 – Non-Financial Transferable Value
The term “transferable value” refers to all the value of the business that can be sold to and retained by the new owner, even after the former owner has left the organization. This includes the financial aspects of the business (the revenue and profit levers discussed above), but also non-financial aspects of the business.
Non-financial transferable pieces of the business can have a huge impact, both positive and negative, to a company’s value.
Here are a few areas of transferable value that, with some intentional effort placed on them, can have a positive impact on your company’s value:
Intellectual property – Do you have specific methods of doing things that can be protected, or do you have industry-unique names to your products/services?
Efficient, documented processes – Processes that are trainable, retainable, and scalable will show the buyer that the knowledge in your organization is not limited to the owner, but that it is ready for growth.
Clear roles and responsibilities – This not only helps your staff to be more effective and engaged, it also shows the buyer that the organization’s work is well defined and allows for decision making responsibility to be shared throughout the organization.
Healthy Workplace Community – An energetic, engaged workforce can have a tremendous improvement on the value of a company; the corollary is also true that a low-energy, non-engaged work environment can not only lower the value, but drive away many buyers.
Effective Management and Supervisor levels – The management layer of the organization is so important because it manages 75% of the human resources in the company. A buyer who finds a strong management team will know that the work will continue to get done without the current owner.
Systematic revenue generation not dependent on owner – For many small businesses, the owner is the main “rain maker”. Take away the owner, and the sales pipeline dries up. Make sure your sales process involves more individuals than the owner, and you can show a systematic method for generating leads that turn into revenue.
Strong brand – A clear brand that has a good reputation in the marketplace can provide additional value to the company since it easily transfers to the new owner. If your branding includes clear offers that are differentiated in the marketplace, this provides an additional boost to the transferable value.
Knowledge how company makes and keeps money – When the entire organization knows how the company makes and keeps money, everyone is thinking of ways to make incremental improvements. How would a potential buyer react to sitting down with an entry level employee who can explain how the company makes money?
Proper contracts with customers and vendors – Having your agreements with customers and vendors in place and reviewed by an attorney can ensure small details don’t hurt your valuation. A simple example is having an assignment clause in your customer and vendor agreements.
Clean Financials – If your books are clean and easy to understand, it goes a long way to assure the buyer that there is no “funny business” going on in the financials.
If your company valuation isn’t what you wanted, don’t throw your hands up in defeat. That’s the experience of nearly every business owner having their company valued for the first time. The good news is that there is something you can do about it; and it doesn’t have to take a long time to achieve significant results – see how we grew our business value by 10x in three years here.
Use these three levers – Revenue, Profitability, and Non-Financial Transferable Value – to begin moving the needle towards your ideal valuation. You’ll actually find it adds a new dimension of satisfaction to being a business owner; and you might be surprised to find that you are enjoying running your company in a new way.