Welcome back fellow investopreneurs to issue #302 of our weekly newsletter, and we hope you are all enjoying your 4th of July weekend🧨!

This past week we asked 50,000+ of your fellow business owners

With an total combined aggregate of 86% of you wanting to know how to value your business and increase it’s value over time… that is what we are going to dive deep into today.

This week’s poll

Don’t forget, if you’d like to work through your own business valuation — reach out to our business brokerage team over at SimpleBroker.ai 

Understanding Business Valuations and Building Wedge Equity

Introduction

Valuing a business accurately is crucial for owners, potential buyers, and investors. The worth of a business can determine strategic decisions, funding opportunities, and exit strategies. This article delves into the essential elements of business valuations and introduces the concept of wedge equity—a strategic approach to enhancing the value of a business by leveraging brand and operational equity.

What is My Business Worth?

The primary question every business owner asks is, "What is my business worth?" Business valuations are complex, involving multiple factors and methodologies. The valuation process aims to provide a realistic and comprehensive picture of a business's market value.

Why is My Business Valued at That?

The valuation of a business depends on various metrics and financial statements. Two critical components of this process are Brand Equity and Operational Equity, which together form Wedge Equity.

How Do I Increase That Value?

Increasing the value of a business involves enhancing its brand and operational equity. This strategic approach can significantly impact the business’s market value.

Brand Equity x Operational Equity = Wedge Equity

Wedge equity is the combination of brand equity (the money multiple) and operational equity (the risk ratio). Understanding and optimizing these components can lead to a higher valuation.

Brand Equity: The Money Multiple

Brand equity refers to the premium a business commands due to its brand strength. This includes the business’s reputation, customer loyalty, and market position. The money multiple is determined by the business's trading multiple, which can be based on seller discretionary earnings (SDE), EBITDA, or revenue.

Operational Equity: The Risk Ratio

Operational equity addresses the operational efficiency and risk factors associated with the business. This includes the business's transferability, liability, and asset status. Buyers consider the type of discount they might apply due to perceived risks.

Reverse Engineering Equity

To build wedge equity, follow these steps:

1. Value the Business: Determine the current value using standard valuation methods.

2. Identify Gaps: Pinpoint the areas where your business falls short.

3. Fill or Remove Gaps: Implement strategies to address these gaps and enhance both brand and operational equity.

Approach to Valuation

1. Start with Net Profit: This is the bottom line from the profit and loss statement after all expenses are deducted from revenues.

2. Add Back Non-Recurring Expenses: Include one-time expenses that will not continue in the future.

3. Add Back Owner’s Discretionary Expenses: Consider personal expenses that a new owner would not incur.

4. Add Back Owner’s Salary and Benefits: Include compensation and benefits provided to the owner that may be adjusted by a new owner.

5. Assess the Risk Ratio based on Operational Equity gaps to discount the value of the multiple

Calculating SDE

SDE=Net Profit + Non-Recurring Expenses + Owner’s Discretionary Expenses + Owner’s Salary and Benefits

SDE Multiples by Revenue Range

Different business models command different SDE multiples. Here are some examples:

Apply the Risk Ratio

Look at all of the drivers associated with brand and operational equity based by the stage of the business (there are hundreds of them) and apply a scoring system to assess where gaps live.

Add up all of the scores and divide it out to calculate a standardized risk ratio that will discount the overall multiple you will see on your business.

This will help to factor in the risk of your business to the value itself.

Building Wedge Equity

To build wedge equity, focus on enhancing both brand and operational equity.

Brand Equity: Four Pillars of Customer Acquisition

1. Cold Relationships: New customers with no prior engagement.

2. Warm Relationships: Potential customers who have shown interest.

3. Earned Relationships: Customers gained through organic means such as referrals.

4. Paid Relationships: Customers acquired through paid marketing efforts.

9-Cs of Retention & Value

Customer retention is crucial for brand equity. The 9-Cs include:

1. Communication

2. Consistency

3. Commitment

4. Customization

5. Connection

6. Convenience

7. Care

8. Community

9. Continuous Improvement

Diversification of Customer Portfolio

Ensure a diverse customer base to mitigate risks and enhance stability.

Operational Equity: Simple OS by ‘Exit’

Operational equity involves streamlining operations through the ‘Exit’ strategy framework:

1. Exit 1: Streamlining processes.

2. Exit 2: Enhancing operational efficiency.

3. Exit 3: Mitigating risks.

4. Exit 4: Increasing transferability.

5. Exit 5: Ensuring scalability.

Profit-Led Financial Accountability

Maintain financial accountability focused on profitability to ensure sustainable growth and operational efficiency.

Conclusion

Business valuations and wedge equity are integral to understanding and enhancing the worth of a business. By focusing on brand equity and operational equity, business owners can strategically increase their business’s value and ensure long-term success.