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3 Common Financial Mistakes that Can Decrease the Value of a Business
by Collective 54

Buyers pay more for quality professional services firms. If you work diligently to grow and improve your business, buyers will be willing to pay more for it. There are many factors that will pique a buyer’s interest and drive the best possible price. While owners tend to focus on the top line, which is important, there are many other critical areas that need to be considered. 

  • Increasing Revenue & Profits
  • Growth Potential
  • Clean Financials
  • Solid Management Team
  • Quality Products & Services
  • Strong Sales & Marketing
  • Low Risk
  • Systems & Processes 

Owners must be vigilant about keeping their businesses competitive and growing, in order to maximize value and ensure their largest asset is protected. All professional services firm owners should perform a detailed review of their businesses well in advance of considering any type of transaction. This exercise will uncover items that need to be addressed and/or corrected long before an internal or external buyer’s scrutiny or due diligence begins.

Look for and shore up weaknesses, such as missing corporate meeting minutes, customer bad debts, undocumented policies and procedures, the lack of written job descriptions, insufficient employee non-compete agreements, environmental issues, and so on. Here are three common financial mistakes that can decrease the value of a business:

1. Focusing on Tax Minimization — Many business owners operate their companies to minimize income taxes. However, this is not the best practice when it comes to maximizing business value. Minimizing taxes while preserving the true profitability of the company makes good business sense, but minimizing taxes by artificially lowering profits can cost you a staggering amount during the sales process. In an effort to pay the minimum amount of taxes, many owners run “lifestyle businesses.” By that we mean the owner seeks to take as much money as possible out of the professional services firm in order to fund the family lifestyle and keep his or her tax burden to a minimum. Unfortunately, this money is usually spent on an increasingly expensive lifestyle and is rarely saved for the owner’s future needs. This is actually just a form of consumption, rather than the creation of wealth, which would occur if the business were treated like an investment.

2. Driving revenue rather than margins  — Of course, it is important to have increasing revenue. However, profit margin is often ignored in the process, which can decrease the value of a business. Gross profit margin is the percentage of revenue you retain after accounting for direct costs referred to as “cost of goods sold”. Companies that sacrifice their margins in order to keep gross revenues high reduce their overall profitability and company value, and they weaken their position in the marketplace. One key strategy for increasing margins is to add recurring revenue to your business, such as:

  • Service or maintenance agreements
  • Long-term service, or retention, contracts
  • Subscriptions for products, services, or information
  • Long-term memberships

Recurring revenue is guaranteed revenue, at least for some time, which does not require the same level of sales and owner effort as project-based, or one-time revenue. This revenue often has much higher margins and is always highly coveted by buyers. Studies show that businesses with recurring revenue sell at much higher multiples than those that don’t.

3. Dependence on the business owner — Perhaps surprisingly, revenue is not always the most important value driver. In fact, one of the biggest concerns a buyer usually has about a business is its dependence on the current owner. Not only does this cause a business to be unattractive to a buyer, but it also creates great risk for the current owner. How would that business continue to function and prosper without the owner? Too many times, an owner has the business relationships, processes, procedures, and technical know-how all under his or her control. In some extreme cases, you could actually say that the owner is the business. This is the direct opposite of what appeals to a buyer.

If you have been treating your business as a lifestyle and some of your value drivers are not up to par, it may take years to sufficiently correct these factors and maximize your business value. With ample time and good advice, most professional services firms can greatly improve their opportunities for selling and the value they will receive. We strongly recommend that owners seek comprehensive, holistic advice in preparation for any sale. There is no substitute. This is most likely a once-in-a-lifetime transaction, and you cannot afford to make a costly mistake.

At Collective 54, we provide personalized guidance from a core group of trusted peers to navigate the challenges of preparing to exit your firm. You can vet decisions by an experienced peer group who will offer unbiased advice in a confidential environment to transition your business. Join Collective 54 to engage in a multi-channel program specifically designed to help members successfully transition their firms, through the integration of principles and practices of preparing for a successful exit.