Something a lot of people are curious about, is how they can exit their business. For some, this means simply taking a hands off approach, building the processes, systems, and having the right people run the business while you collect money.
For others, this means building a business you can sell.
That’s what we’re going to talk about today, and even though this is about agencies, web design, SEO, digital marketing companies, etc. a lot of these things can be applied to other businesses.
In this post you will learn:
- The art of valuations, and the differences, offline and online
- How to create a business that is valuated at a higher amount
- Why certain things that allow some businesses to survive and thrive, aren’t valuable when selling
- How to build assets that add value to your company
- And other cool stuff!
Let’s get started!
Business Valuations – How Much is Your Company Worth?
That’s the question.
You guys have probably seen business news about silicon valley tech companies receiving absurd valuations, on the premise of potential growth.
It’s kind of crazy, how can you have a 300 million dollar company when you have absolutely no revenue?
Even though we’re in digital marketing, we do not get the same lenient standards for valuations that venture capitalists in silicon valley give out to tech companies. We’re not really a tech company, we’re in a service based industry.
For them, the potential of growth through commercial clients using their software is good enough to get a good valuation. For us, the future doesn’t matter because we don’t have a proprietary asset like they do.
This stuff can be quite complex, but here’s a run down of the type of valuations:
(Note: You basically should form an LLC, S-Corp or C-Corp LOOOONG before ever thinking about selling your company. Here’s more info on the differences: Small Biz Owner’s Secret Guide to Taxes and Business Entities)
Asset Based Valuations
This is when you analyze the value of your company by subtracting all liabilities such as bills, hosting, office space, employee salary, etc. from your assets.
What can be an asset? For us, they are clients that are paying you some sort of recurring income, think local SEO, hosting, reputation management, support contracts, etc.
They can also be proprietary software, systems, platforms, even training programs for freelancers or employees.
A CRM, even if it wasn’t developed by you, is an asset. Whether you use Salesforce, Pipedrive, Nutshell or other CRMs, having a database of prospects, or leads that you’ve had in the past, has value. It is an asset. We’ll talk more about assets later on in this post.
For offline businesses, assets could be inventory, a customer database, and equipment.
Most buyers of businesses, will try to give an asset liquidation based valuation, which means your business is valued based on assets of the current year. This usually isn’t a good deal, unless you’re desperate.
Earning Value Based Valuations
The more common form of valuating a business is by earning value. This means that you’re selling based on the fact that you expect revenue to continue for years in the future, and at a higher rate of increase than you’re currently experiencing.
Those interested in buying your company, will likely do something called “Capitalizing past earnings”, which they look at your previous earnings each year, figure out the rate of increase, and basically set a target for what they can expect to make in the next 3-5 years.
Their target, is what they expect to make, and usually they’ll make a sale price around 50% of that number, sometimes a bit smaller because many businesses have customers that are personally tied to the owner.
The more you build systems and processes that allow the business to run without you, the less of a deduction will be made when it comes to landing an acquisition.
Market Based Valuations
These types of valuations, will be what you will use in order to milk more money out of a deal when you’re trying to sell your company.
To put it simply, you compare related businesses in the same industry and see what they were acquired for.
Pretty simple right?
It’s actually pretty difficult to find a list of comparable businesses that have sold, but if you can, then that’s the best way to go.
How much is your business worth?
Take bits and pieces from each valuation model.
Using an asset liquidation based valuation, you should find the minimum value point for your business. For example, if you are profiting $80,000/year, then you have 80k in assets. Additional assets could boost that value and that would be your minimum selling price.
However, you can take a part of the earning value based valuation. For example, if you’ve been in business for 3 years, and you’ve seen 20% increases for each year then this is what your past income looked like:
Year 1 – 80k
Year 2 – 96k
Year 3 – 115k
This means you would be able to add to your valuation. While buyers are looking at 3-5 years in the future, you can only reasonably account for the next 2 years, but not based on commutative growth, just the year 2 expected revenue projection. Instead of the 115k in assets at this point, you would be able to add an extra 50k to reach a better valuation.
Year 4 -138,000
Year 5 – 165,600
But we’re not done yet. Assuming there’s data available for similar businesses that have gone through an acquisition, we can create a sample group, take their average profits and average the acquisition price. Is it in line with your valuation? If not, compare the proportions (do a bit of math) and adjust so you’re in the same range.
Easy way to go from the 165k valuation after the earning value adjustment to find yourself in 250-300k territory.
Offline, Online, and Our Valuations
Typically in offline businesses you will see people discuss businesses being sold for 3-5x profits or 1-1.5x revenues. I’ve seen articles on entrepreneur and businessinsider that suggests those are normal valuations and acquisition prices.
Unfortunately, it’s not that simple. Those businesses are usually pretty lucky to sell for 5x profits, and especially 1.5x revenue. It’s pretty rare for a business to get 3x profits. Usually we’re at 2x profits, or .5x revenue.
Online, it’s even worse. You don’t see many sites, online businesses, side hustles, affiliate sites, etc. sell more than 1x earnings. Meaning, you don’t see them sell for more than what they make in a year, very often at all.
And possibly even more demotivating for agency owners and all you freelancers out there, is that your profits don’t really matter. You could be profiting 100k/mo but if 80% of that comes from one time payments, then your valuation is going to be based on the 20k/mo, but not for a full year like some offline businesses, not even 10 months like some online businesses.
For local SEO, or SEO clients in general, your maximum value you can get in a valuation is usually going to be around 3 months.
Sounds awful right?
I’ve been through it.
And because I’ve been through it, I might be able to help you do better than I did.
Why Creating Recurring Income Is The Most Important Thing
So you’ve already received the bad news. Let’s make it a bit better.
In order to do that, we need to focus a lot more on recurring income.
In agency land, we have a lot of ways to produce recurring income. Local SEO, general SEO, social media management, reputation management, hosting / maintenance, PPC. support contracts, etc.
Very few people are implementing it the right way though.
Let’s Talk SEO
One of the biggest surprises of mine, was how little, companies valued recurring income from SEO clients.
Some of you have asked questions over the past year or two, like “Why do you say the average client stays with a company for 3 months”.
Maybe you have better averages. I certainly did. However, even if you had clients for 3 years, paying for SEO each and every month, they are only valued at 3 months of income. Why? Because that’s what venture capitalists, business valuation companies, and other companies in the industry believe is the length of time those customers, on average, will stay with a new company, because they’ve already figured out it was the industry average!
What About Hosting & Maintenance / Support?
Hosting and maintenance is usually viewed as longer term clients and valued much higher or maybe I should say longer than a typical SEO client.
Instead of 3 months of value, the industry sees it as 3 YEARS of value! I guess it kind of makes sense. If you look at some hosting affiliates, they’re paying out commissions well over their 1-2 year value.
Maximize Value by Offering SEO, Without Offering SEO
I played around with a few different offers to see what different types of companies would buy. There were some clients that wanted a full range of services, from local search, to organic, to ppc, social media, ORM, and other stuff.
It gave me an idea to accomplish 2 things.
1.) I wanted to overcome the SEO bias that exists in a multitude of companies
2.) I wanted to charge more and position it as a full service online visibility program
This allowed me to place a large focus on SEO, but do a few other things as well and charge a higher fee for larger companies.
Little did I know these clients would boost my valuation and no longer be treated as SEO clients. Instead, the average lifespan of these clients were used as part of a valuation.
For example, if the average lifespan of a customer on this program was 14 months, it would add value based on 75% of the average life span. Of course, there’s an additional risk adjustment, but either way it’s far better than the 3 months maximum you get from SEO clients.
But Ignoring One Time Payments will Cost You
Just because recurring income is the most important thing when it comes to determining valuations in this industry, doesn’t mean that you should ignore one time payments, like setup fees, web design projects, etc.
It’s true, that revenue derived from one time payments, will not be factored in under projections and valuations, but the cash flow you have on average is something that will be considered. Also, your customer base, whether recurring income or not, also has a value. After all, isn’t easier to sell to a current customer than it is a lukewarm lead?
For some reading this, and some regular readers here overall, a lot of you are chasing the recurring income but you’re missing out on a few key things.
- One time payments provide an influx of cash, which as a business you need just to survive and get to the next level.
- They provide cash reserves that allow you to market your business and achieve better growth.
- Sales goals… hello? Not only does it boost your overall revenue which can be used to build additional assets, but it creates opportunity within your company. If you’re at the point where you have a sales team, then you can afford to give hefty commissions on the front end and make your money on the backend with recurring services.
- Speaking of additional assets, higher revenue, whether from recurring or one time payments, allows you to build better business credit.
- Needing money for holiday bonuses? Want to attend a conference? Get married? It’s easy to sell to your existing customers, one time sales like graphic design + printing.
What Type of Assets Should You Have?
Technically speaking, a client that is paying recurring income is an asset. For the purpose of this post though, I’m going to dive into some other areas that you should have because they can be considered an asset in a valuation or acquisition of your company.
There’s a LOT you can do that won’t be included in this list, so keep in mind this is just a small selection of things you can implement to bring more value to your business. These are pretty easy things that won’t require thousands of dollars and a ton of hours to develop proprietary software, scripts, etc.
Use a CRM Dummy!
Okay, the dummy was targeted to someone that doesn’t want to use a CRM because it’s complicated and a “yellow pad is easier”.
Here’s the thing, not only is a CRM good for managing a bunch of leads, it helps you see your current pipeline value. It helps you make sure your follow up is on point, to not lose any leads through the cracks. Good follow up will close sales.
It’s a necessary tool for your business, but it’s also something that can be considered an asset.
Companies buy leads. Almost every major company buys leads. From time warner cable, to yellowpages, yellowbook/hibu, angieslist, even the BBB.
A CRM stores leads for you, and whether you have “lost leads” or uncontacted prospects imported into your CRM, it has value.
For example, yell bought a website design company and this company had a CRM with about 80,000 leads. 5,000 leads were listed as lost, but 75,000 that weren’t already clients, were uncontacted businesses. They were simply imported in the CRM as a cold contact list. This added roughly $15,000 to their valuation. Yell probably made that back in the first week of re-contacting those 5,000 lost leads. In fact, they probably had a 300-400% ROI from the added 15K for the CRM details.
Project Management Processes
This is something that may or may not help you when you’re trying to sell your company. Usually larger companies that are buying smaller companies, already have their fulfillment process setup.
However, in my own experience, what helped me was that when I acquired a small company for their hosting clients I needed to automate a lot of help desk and maintenance issues.
I had a system setup where clients had an issue, their emails / help desk tickets would automatically be synced with my project management platform and auto assigned to one of my VA’s.
This process I created out of necessity, was considered an asset. A simple help desk works for some, but when you’re dealing with clients wanting changes on their website, whether it’s to add a sentence, reword something or add a new picture it can be overwhelming when dealing with volume, and that’s just from a management standpoint, not fulfillment.
How Many Emails Do You Have?
You guys already know my thoughts on cold emailing. It’s such an easy way to generate leads and land sales, that if you’re not doing it, you’re missing out on one of the best ways to boost revenue.
If you haven’t started, please, start now. Get a scraper, and start sending. Get Ice Cold Email Gold while you’re at it and save yourself some trouble.
Anyway, not only is it something that’s great for generating leads, it’s something that is considered a business asset.
Being able to send to 100k businesses at any time you want, is a HUGE asset.
For me, having a large list of emails, that I communicated with weekly for years, gave me a big boost in valuation. Having 3+ MILLION business emails that has been cleaned, been opening messages, clicking, interacting with the company, was something that not a lot of companies are able to do.
I did the hard work of building the list. I didn’t say it was a cold list of scraped emails, because it didn’t matter. I had above industry average open rates and engagement from the emails. These emails were no longer cold. You should be doing the same.
Building Business Credit
Yeah, I know a lot of you are against having debt. That’s fine, but what if having business credit available, would increase the amount of money you can get when you try to exit your company?
No one says you have to use business credit.
Having it available, is just good business though, forget what Dave Ramsey says about your personal finances.
Within 1 year of operating a business, you’re able to create about $100,000 in available credit through trade lines, credit cards, lines of credit, etc.
Getting started is pretty easy.
- Make sure you have an LLC or S-Corp (C-Corp is fine too)
- Make sure you have an EIN (takes 5 minutes on the IRS website)
- Register for a D-U-N-S Number with Dun & Bradstreet (FREE, don’t buy their credit builder service)
- Establish a tradeline / NET 30-90 accounts, like quill.
That’ll probably get your paydex score decent enough to where you can get business plans setup with any major cell phone provider without a deposit.
Of course, there’s a bit more to it, and you would want to get some revolving credit available to you but you’ll have to do some research on that, because that’s something I can discuss in another 3,000 word blog post..
The thing is… some companies buy other companies JUST BECAUSE of their available credit.
Funny enough, it isn’t just companies buying other companies. There’s a pretty big market for “shelf corporations” that exist only for the purpose of building credit, and selling to individuals that have poor credit and want to legally rip off people that extended credit to these non-existent companies.
If people are buying companies, just for their purchasing power and available credit, it seems reasonable to expect other companies to value it as well, right? Right.
You’re essentially GUARANTEED that a minimum of 10% of your “available credit” will be added to the purchase price or valuation.
There’s also a lot of shady stuff done by companies making acquisitions, but that doesn’t effect you, so we won’t get into that here. The point is, your available credit has value, real money value.
Surprisingly Enough, Content is an Asset as well
Maybe it isn’t a surprise.
A lot of digital marketing agencies aren’t utilizing content and are ignoring one of the best assets to have in your business.
Content marketing is growing. Major brands are implementing a stronger focus on content marketing, and in our industry, having good content not only can bring in top of the funnel leads, it also assists in lead nurturing and taking leads from one part of the sales process to another.
Obviously, search traffic associated with that content has a value. Some companies that make acquisitions will assign value based on your organic reach and traffic.
An easy way to show you have a valuable asset, is to set up goals in Google Analytics to track conversions of your search traffic. If you get 5,000 organic visitors on a monthly basis from your content, and you have a .5% conversion rate, that’s 25 leads you’re acquiring on a monthly basis.
Leads always have value right? If it takes 10 leads to make an average of 1, $1,000 sale, then each lead is worth $100 average. 25 leads a month is $2,500 in value, multiplied by the industry average of this valuation method of 9 months, you added $22,500 to your company’s valuation.
Figure out what it is for you.
There’s also less conventional ways to turn content into an asset. An automated funnel is one of these ways. As well as creating a content based training program or wiki for employees. These things have value, even if not used by the acquiring company.
I realize this type of topic is kind of “in the weeds”. It’s not popular content, I couldn’t even do much in terms of google searching to find out what other people are saying and to see if I’m being as thorough as them. So currently, this is the best information available on the interwebs as far as I can tell.
In the digital marketing world, often times you won’t hit a major payday when selling your business. It’s usually more profitable to stay in the business, but hey, if it’s a lifestyle decision and you’re just “done” with dealing with clients, I get it.
Hopefully this might help a couple of you at some point.