Maximize profits to increase value.... It's elementary.

• Author: Hughes, John M., Jr.
• Position: GUEST COLUMN - Column

In today's business world, many baby-boomer business owners are transitioning ownership of their businesses and looking to maximize value. The answer to maximizing value is similar to the one Sherlock Holmes would give to Doctor Watson: It's elementary; increased profit equals increased value.

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Most business owners focus on the day-to-day operations of their business, including growing revenue, adding staff, reducing taxes and even making profits. Far fewer business owners link profits and value, and as a result they spend little time increasing the value of their company.

Businesses generally sell for a multiple of adjusted earnings, which can be measured by cash flow, EBITDA (earnings before interest, taxes, depreciation and amortization), discounted future cash flow and other ways to measure profits. The bottom line is the bottom line--profits. Privately owned businesses generally sell for three to 10 times their earnings.

The average multiple paid for a profitable small business in today's market is 3.5 times EBITDA, according to John Ingell, who owns SBADenver, a local business brokerage firm that is part of the global Sunbelt Business Advisors sales and acquisitions network. This is very dependent on the risk profile of the business and the industry, the type of buyer and the financing availability.

A small business that is well run and in a strong market segment that becomes the target of a strategic, publicly owned company could go for upwards of six to eight times EBITDA or more. The definition of a small business by the Small Business Administration varies significantly depending on the industry in consideration, with sales generally less than $20 million and fewer than 500 employees.

Tom Heule, a partner with Denargo Capital and a participant in numerous private business mergers and acquisitions, says earnings multiples are increasing and that the most profitable businesses receive even higher multiples.

In other words, a business that has net profits of 5 percent of revenues may sell for three times adjusted earnings, while a competing business in the same industry that earns 10 percent of revenues may sell for four times adjusted earnings. Buyers will pay a premium for businesses with higher than average profits.

Increased profits equal increased value, but business owners rarely take the time to pull themselves out of the day-to-day operations and analyze the profit...