For most owners of businesses, sitting behind a computer on excel is not the most inspiring thing in the world. Most intimately understand how their business makes money and what are the largest cost centres. But when it comes time to value or sell your business, often a buyer will want to see a clear economic model produced.
Having a 3-way financial model gives you the power to communicate the value of your business in a more convincing and concrete way. These can be used in a number of different ways, including:
- Creating a more accurate business valuation
- Backing up your business plan
- Communicating with investors or buyers
Here's our guide to how a 3-way financial model can help your business. For tailored advice or a valuation for your business, talk to the team at Nash Advisory.
What is a 3-way model?
Items that are typically within a 3-way model include:
- Profits per service or product
- Revenue per customer or service line
- Assumptions relating to costs and revenue
- Capital expenditure to be spent on the business to help produce the revenue
- Taxes, depreciation, seasonality, and gross profit
Why you need a financial model when selling your business
Buyers of larger businesses outsource a large part of the due diligence exercise to the Big 4 transactional services accounting firms to assist them with their investigations on the business.
Potential buyers and external advisers sit in an office away from your business and have not had the benefit of meeting you, your team, and the business premises to see how the business operates. So when it comes time to sense check the data your business sends a buyer, they will naturally have many questions.
Simply producing a profit and loss statement and balance sheet to a buyer is the bare minimum when embarking on a sale event, and should be avoided at all costs. Ensuring there is a clear figure and story behind each assumption is important in the steps of the sale process.
The value of a 3-way financial model
When selling your company, you can’t say “revenue will grow 25 per cent this year” and not back it up through a clear financial model and assumptions. You would lose credibility and therefore lose the ability to negotiate a great position when the negotiations get real.
Having clear visibility in the numbers by producing a 3-way financial model assists the process in several ways, including:
- Buyers or investors can understand the business model faster, reducing transactions costs and time wasted
- Understanding where key revenue lines are sourced from as well as cost drivers
- Providing a clear set of numbers which stacks up from a financial forecast perspective
- Allowing the owner to sell the business off a future profit number rather than a historical figure, potentially adding additional value
- Buyers can critically analyse your business’s growth assumptions and data
- Giving confidence in the data may reduce or totally eliminate the need for any retentions, holdbacks or earnouts given how clear the forecast financials are presented
Example 1—increasing business value by simply creating clear data
There is a $5 million swing factor in the above example, as the selling company is in a much stronger negotiating position than the buyer, given the supporting data around the future financial performance in the data.
Example 2—reducing earnouts, holdbacks or retentions
Say, the business makes $6M and the EBITDA Multiple is 5 times:
In the example above, the buyer does not require any funds to be held back because they are confident in the validity of the business, shown through the financial model.
Without a financial model and a range of varying assumptions about the growth, a buyer is less likely to understand or trust the growth projections and therefore may seek to hold back a portion of the funds for a period of at least 1 year.
Producing a 3-way financial model is about creating an additional advantage when selling your business. It gives you the option to increase the sale value plus limit any funds required as a retention, to allow the seller a clean and well timed exit.