Whether you are building your business for eventual sale or to bring on investors, you need to have a good grasp on the key metrics of your business and understand what your target investor is going to be looking at when assessing the value of your business.
Measurements:
Total Revenue - This is usually looked at over the trailing 12 month period and encompasses the paid revenue of your entire business (we’ll get into breaking it out by type later). This is not the same as the amount you invoiced our clients, it’s how much you actually got paid in that time frame.
Revenue Quality - What is the make up or ‘mix’ of your revenue. How much of it comes from one-time services vs recurring subscriptions vs other offerings like equipment sales or materials? What is the margin on each of these various revenue types. You may have a high margin on subscriptions but then be selling holiday lights for a very low margin - it’s important that you can break these out by type/category so you can see the ‘quality’ of your revenue by type and not just blended together.
Growth Rate - how fast are you growing your revenue year over year. It is also helpful to break this down each quarter vs the prior year, that way you can show a trend on growth and ideally prove that growth is sustainable and consistent over time. It’s very easy to calculate this figure, just take your revenue at the same time last year or last quarter and look at how much you added. Then divide the increase by the starting figure to get the % growth on a quarter over quarter (QoQ) or year over year (YoY) basis.
Churn in Dollars and Logos - how much of your subscription revenue is keeping your year over year and how many of your customers are continuing with their subscriptions. This is not something you can easily calculate on one-time services since there is no real promise of future business in those accounts. But for maintenance contracts or service agreements you should be able to look at this figure. By calculating what % of your recurring revenue/customers is leaving each quarter or each year, you can extrapolate the amount you need to replace in order to maintain or grow this revenue stream for your company.
Gross Margin - This is important b/c it reflects how much you have to spend to deliver your services. This is usually calculated as your revenue minus the people/materials you need to deliver the service. So for instance if you have 100k in monthly revenue but spend 30k on your staff and 20k on materials then you’d have a 50k gross margin - usually reflected as 50%. Other costs will come into play further into your P&L but this one is designed to show how much money you have to operate the business after you perform the delivery of your services.
EBITDA - “Earnings before interest, taxes, depreciation and amortization” - this is the money you have left over before the listed items are covered for. This number is very commonly looked at to see if you are able to run a business that has the potential for profit even before you cover things like loans and taxes (which vary from market to market). It’s designed to create a universal baseline for measuring profitability between markets and types of businesses.
Free Cash Flow - This is similar to EBITDA but takes Taxes and Interest out of the equation to see if you are able to create money to invest back into your business (which you might do in order to avoid a tax bill or in the event you don’t have any loan interest due). Companies with strong free cash flows have the opportunity to grow faster if they reinvest that money in more capacity and revenue generation.
Cap Table Structure - Who owns what % of the business - that is what a cap table (capital ownership table) is at the most basic level. This matters b/c the more people on the table, the more complicated things can get when it comes time to sell or raise money. Also, if there is no single majority owner of the business, you may need to get multiple owners to align on investment or sale, adding complexity to any funding events. Most small businesses look to keep the cap table as s
Valuation Methods:
Whether you are going to raise money to invest into the business or to take some of the created value ‘off the table’ and sell some portion (or all of) the business. Investors are going to use a couple of basic methods and principles for valuing your business.
Multiple of Revenue - Take your total revenue and then multiply it by 1 or 2 or whatever. For businesses with gross margins below 50%, this is not the most common method. However if you are showing very strong revenue growth, and low churn, you might be able to ask for a revenue multiple of 1-3x or try and project a 1x multiple on revenue a year or two into the future. If you have low growth, this method is probably not for you.
Multiple of EBITDA - It is extremely common for home services businesses to be valued as a multiple of their EBITDA. The new buyer or investor is assigning a multiple to how much money the company is likely to generate. You could be looking at 3-5x multiple but that number can vary wildly based on your overall size and future growth projections.
Discounted Future - Whenever you are asking an investor to give you credit for future growth, they are going to discount that future revenue b/c it is not guaranteed. The further out the target is set, the more they will discount that likely outcome. If you are able to show strong consistency in your growth figures you can push for less discount in the projections.
Cost of Capital - What will the investor have to spend on the money they give you? How much could they earn if they put that money somewhere else? As interest rates go up, investors have an opportunity to make more money with very little risk. When interest rates go down, investors tend to look for other places to put money. The other way around is that if it costs a lot for an investor to go get a loan to buy your company, they are going to factor that into what the value of your business is.
Considerations:
It’s an investors job to get the best possible price. They will be looking for ways to “discount” your value wherever possible. That's why having your numbers dialed in and being able to show the underlying data to substantiate your figures is so important. Investing in a strong back office tool set or accounting services might seem like a ‘sunk cost’ but it will pay off BIG TIME when it’s time to run through an investment due diligence process.
When you are looking for an investment/exit event, consider running a process and running it like a sales funnel. You might talk to 20 initial targets that you narrow down to 10 based on mutual interest. From there you could identify 3 ‘best fit’ targets for the goal you have. Then you can go through a bidding process with a small set of very well qualified candidates. This will help you avoid wasting time on poor fits or relatively uninterested parties.
Consider using a 3rd party to run the process. There are plenty of banking services that can help you run your ‘process’. This is a strong recommendation for most situations. Not only can these groups help bring you a set of pre-qualified investors, they can also handle a lot of the legal complexity and back and forth negotiations. We have multiple examples of companies that ended up getting DOUBLE the value they were initially looking for based on the support of a 3rd party to help them run their process. Sure, it’s going to cost you some money to utilize a service but if they insure a significantly improved outcome… who cares.
TRY not to take things too personally. This is hard, we know. You build your services business and it’s personal to you. But remember, it’s probably NOT personal to the people on the other side. Moreover, if the plan is to continue working with the new investor/owner, you want to prevent that relationship from starting out on a bad foot. This again is where a 3rd party can help insulate you from some of the process that might wrinkle your feathers a bit.
Have a target in mind - consider what you’d do if you can’t get what you want and what you’re willing to accept. If you are looking to sell 50% of the business for 5M and the best you can get is 2M is that a number you are willing to accept? If not, what is your back up plan? Think through your options and your goals before you go too far down the process. That way you aren’t trying to figure out what you want based on someone else’s offer.