How to Increase Margins Before You Sell

Pricing

Most small businesses have not raised prices in proportion to their costs. Owners fear losing customers, so they absorb increases in labor, materials, insurance, and rent, and the margin shrinks a point or two a year without anyone deciding it should.

Look at when you last raised prices and what your costs have done since. If costs are up 15 percent and prices are up 5, you have given away 10 points. A 5 to 8 percent price increase across the board, with a short note to customers, typically loses very few of them and drops almost entirely to the bottom line. On $2 million in revenue that is $100,000 to $160,000 in earnings.

Do it at least six months before listing so the effect shows in the trailing twelve months and buyers can see the customers stayed.

Separately, look at your lowest-margin customers and services. Every business has work it does at cost because it always has. Reprice it or stop doing it. A buyer pays for earnings. Revenue that carries no margin is a cost.

Cost of goods and vendors

Get quotes. Owners who have used the same suppliers for fifteen years are almost always paying above market, because the vendor has had no reason to sharpen their pricing. Two or three competing quotes on your largest purchase categories, presented to your current vendor, usually produce a reduction without switching.

Look at waste, spoilage, shrink, and rework. In restaurants, food cost that runs 34 percent when it could run 30 is $80,000 a year on $2 million in sales. In manufacturing and construction, scrap and rework are often unmeasured. Measure them.

Check whether you are taking early payment discounts and whether you are being charged for freight and fees that could be negotiated away.

Labor

Labor is the largest expense in most service businesses and the one owners are least willing to touch. The goal is matching hours to work, which is different from cutting people.

Pull the schedule against sales by hour or by day. Most businesses are overstaffed at some times and understaffed at others, and the overstaffing costs more than the understaffing saves. Adjust the schedule.

Look at overtime. Recurring overtime usually comes from the schedule.

Look at what you pay for tasks that could be done by someone cheaper, or by software. A bookkeeper at $30 an hour doing data entry that an integration would do for free. A technician driving to pick up parts that could be delivered.

Do not cut the people a buyer will need. Your general manager, your best salesperson, and your senior technician are part of what you are selling. Cutting them raises earnings for a quarter and lowers the price by more than it added.

Overhead

Go through every recurring charge on the credit card and bank statement. Software subscriptions nobody uses, insurance policies that have not been rebid in years, a phone plan from a decade ago, memberships, advertising that has never been measured. Most owners find $1,000 to $3,000 a month here in an afternoon.

Rebid insurance. Commercial policies drift up every renewal and rarely get re-shopped unless the owner asks. A rebid on general liability, property, auto, and workers comp often saves 10 to 20 percent.

Look at rent if you have a renewal coming. Renegotiating from a position of strength, before you are under contract to sell, can lower occupancy cost and extend the term, which fixes two problems at once.

Revenue mix

Some businesses can raise margin without touching costs by shifting what they sell. A landscaping company that moves from one-time installs toward maintenance contracts gets both higher margin and recurring revenue, which buyers pay more for. An HVAC company that sells service agreements at the end of every install does the same. A retailer that expands its highest-margin category and cuts its lowest does the same.

These moves take longer to show up, so start them early.

What buyers will and will not pay for

Buyers pay for margin improvements that are in the trailing twelve months and look sustainable. A price increase that customers absorbed, a vendor renegotiation that is under contract, a schedule change that has held for two quarters.

Buyers discount improvements that look like they were made for the sale. Marketing cut to zero the quarter before listing, a manager laid off in the last month, deferred maintenance, and inventory run down. Their accountant will normalize those back, and the attempt costs you credibility.

Buyers do not pay for improvements you describe but have not made. "A new owner could raise prices 10 percent" is not an add-back. If it is that easy, do it, and get paid for it.

A specific case

A commercial landscaping company with $2.4 million in revenue and $380,000 in SDE decided to sell in eighteen months. The owner had not raised prices in three years while labor costs had gone up 18 percent. Fuel, materials, and insurance had gone up as well.

In the first quarter he raised maintenance contract pricing 7 percent at renewal with a one paragraph letter. He lost two of 140 accounts. That added about $150,000 in revenue at nearly full margin. He rebid his commercial insurance and saved $22,000. He put out his fertilizer and mulch purchasing to three vendors and his existing vendor matched the low bid, saving $31,000. He went through the credit card statements and cancelled $1,400 a month in subscriptions and services nobody used.

In the second and third quarters he rebuilt the crew schedule against the route data and cut recurring overtime by about $40,000 a year without reducing headcount. He stopped taking one-time install jobs under $5,000, which had been running at a loss once travel was counted.

By the time the business went to market, trailing twelve month SDE was $590,000, up from $380,000. The customer count was down by two. At the 2.8 multiple the business supported, the improvements were worth about $590,000 in price, and the buyer's lender financed it without a seller note because the coverage was comfortable.

What did not work

He tried cutting the marketing budget in half. Inbound leads fell within two months and he restored it. He tried moving crews to four ten-hour days, which reduced overtime further but raised turnover, and he went back. Both showed up in the numbers quickly enough to reverse, which is another reason to start early.

The order of operations

Price first, because it is largest and fastest. Vendors and insurance second, because they are one-time efforts with lasting effect. Overhead third, because it is easy. Schedule and labor fourth, because it needs data and care. Revenue mix last, because it takes the longest to show. All of it at least twelve months before the memorandum is written.

Sequencing

Do the pricing and vendor work first, since it is fastest and largest. Then the overhead audit. Then the schedule. Then the revenue mix, which takes the longest. Start at least a year out so the full effect is in the trailing twelve months by the time the offering memorandum is written, and so buyers can see two or three quarters of the new margin holding.

The result of a year of this work on a business with $400,000 in SDE is often $475,000 to $525,000 in SDE and a price $200,000 to $300,000 higher, from the same business, the same customers, and the same team.

This article shares our opinion and general information. It is not legal or tax advice. Always speak with a licensed attorney for legal advice, and a qualified tax professional for tax questions, before you act.