The most important things in valuing a business are detailed financial records, well-documented operations (SOPs) and customer metrics: the long-term value of the customer, the cost of acquiring customers, revenue, and lost customers.
Last week a dozen of our customers were listed as 2018 Golden Fork winners so we will start with the fast food group: Customers on average visit a particular fast food place once or twice a month (we will use the conservative mid-point of 1.5x/month). This customer will patronize the fast food place on average for 3 years.
For a nail salon, your customer comes on average twice per month but will patronize your salon on average for 5 years.
The long-term value of customer = Average Monthly Revenue per customer x Average years a customer will patronize your business.
Cost of acquiring customer (CAC) = Advertising expenses / # of new customers added
The long-term value of the customer: Cost of acquiring the customer.
This ratio will indicate if you are spending too much or what we found more often is that you spend too little and are missing out on growth opportunities.
In a fast food example, a customer spends $20 x 1.5/month x 36 months = long-term value is $1,080.
In a nail salon example, a customer that spends $50 x 2 /month x 60 months = long-term value is $6,000.
This should also serve as a reminder to value your customer for their long-term value and not just their $50 refill or $8 Pho Bowl. The math also reminds you that it is better to have one ideal long-term customer than it is to have more but poorer quality customers.
There will come a point in every business owner’s life that money comes perpetually, like living off a 3% return on $3 million, and you will have to decide if you want to sell your business. You can get a multiple between 2.5 – 4 on the seller’s discretionary cash flow. Internet businesses can even reach 5x multiples.
Your multiple will be the average of the four results sensitive to these 4 metrics:
- The longer you have operated the business and have solid financial records the higher your multiple.
- The more time and technical skills the owner uses to run the business will decrease your multiple.
- Increasing revenue and/or profit trends will increase your multiple, while 0 revenue growth will only command a 2.5 multiple.
- The more loyal your customer base the higher your multiple.
If you operated your business for 10+years, work 25 hours per week in your business, have a flat revenue, but a loyal customer base, you could be looking at a valuation of $1M based on an annual discretionary cash flow of $300,000.
The advantage of internet businesses is even more clear when it comes to selling your business. The smaller your city, the less likely it is you will get your worth when selling your business so the alternative would be just to keep it but reduce your income by 30-50% by outsourcing or hiring.
Money is only a mathematical measure of value, so the key is you should always focus on delivering that value, the money is a by-product. Focusing on making money will only ruin your long-term gains.