Almost all business owners at one time or another need to put a price tag on their business and figure out how to pass along or sell it. This tends to be an emotionally difficult process because your business is more than just a job, it represents years of intellectual effort, energy and passion. These tips will help you navigate the process and come out with a conclusion that will provide you the best basis to make a wise decision when it comes time to sell.
Business Valuations
Some people avoid the valuation process because they internally worry about what a proper analysis will discover. Others try to do the process themselves and never come up with a value that a third party would consider accurate. No matter the reason, you may be one day considering selling your company and a business valuation is the first step. It will help you determine what to expect in terms of payout and how you can best position the company to fetch top dollar.
Many companies periodically conduct a basic business valuation and keep up with the latest mergers and acquisition trends. In each industry, what has value changes as technology develops and markets shift. What has a high value today may not be as sought after in 5-10 years. That is why a periodic business value review, and possibly a full business valuation from an outside consultant, may not be a bad idea. This is particularly true if you have no family to inherit the company and will one day want to sell it to retire.
There are a few basic types of business evaluations.
Typical Business Valuation Methods
• Asset Valuation: Calculates the value of all of the assets of a business to arrive at the appropriate price.
• Liquidation Valuation: Determine the value of the business assets if it were forced to sell all of them in a short period of time (usually less than 12 months).
• Income Capitalization: Future income is calculated based upon historical data and a variety of assumptions.
• Income Multiple Valuation: Seller’s discretionary income (EBITDA plus owner’s benefit) of a business is subject to a certain multiple to arrive at a selling price. EBITDA is earnings before interest, taxes, depreciation and amortization.
• Rules of Thumb Valuation: The selling price of other “like” businesses is used as a multiple of cash flow or a percentage of revenue.
• Comparable Sales Valuation: Value is based on similar recent sales of businesses which are almost identical in regard to location, business type, sales, etc.
While you can do a basic analysis in-house just to get a feel for the standing of your business, you should consider a third party firm if you plan to use an analysis for an actual sales transaction. These third party valuations can be used to line up financing before the sale, resulting in more cash to you. An independent valuation provides a basis for tax calculations and information you will need to review with your accountant your after sale tax situation.
There are two basic types of buyers – financial and strategic. Financial buyers make up an enormous segment of the market. They look for businesses they can buy using debt financing for 50% to 75% of the price, and that have sufficient cash flow to service that debt. Strategic buyers look for synergies with their current operations. They buy a company to gain market share or add capabilities needed to expand in market segments they are already familiar with to some degree. Both types of buyers have different reasons to acquire a company.
Financial buyers tend to use a multiple of earnings to figure out the sales price and will deduct any interest-bearing debt that they will assume. Financial buyers are in business to make deals, so they may overlook some weaknesses and not be familiar with some of the negatives of your existing operations.
Strategic buyers are more likely to pay a premium if your value to their existing operations is greater than your basic financials would be to any general buyer. They may also be more familiar with your market and be more difficult in negotiations if some aspect of your business is not up to par.
Valuations start by examining your financial statements and budgets plans. A detailed financial analysis will help you determine ways to cut costs, reduce poor performing product lines, and increase focus on higher margin areas. At the very least, running your business as if you were preparing to sell it will improve your management practices and increase the value of your company. Many business experts contend you should always be working to position your firm so that it would be attractive to outside investors. Independent financial analysis gives you greater bargaining power and may allow you to demand better terms.
You may also want to provide a detailed analysis of your position in the market compared to competitors, management depth and staff expertise, and new products or services in development. Unique expertise may make the difference between simply selling out and selling up. Also, a business that is excessively dependent on the owner is risky for a prospective buyer. Appointing a second-in-command and department managers enhances a company’s value by alleviating that risk. One way to gather the information needed to sell a company without raising suspicions is to conduct a Strengths/Weaknesses/Opportunities/Threats (SWOT) analysis. You can also work with key managers to develop or revise your business plan.
Ultimately, there is no one right way to determine the sales prices of a business. In reality, the business is worth whatever the top bidder thinks it is worth. At the very least, the company is probably worth at least the replacement cost of its equipment and inventory. Take a look at the company’s assets, including equipment, inventory, intellectual property, etc. You will also want to consider the existing customer base and goodwill as well as the reputation of the firm within its industry. Another major factor is the cash flow of the business and its revenue.
Buyers must be careful because a company can have high revenue but little to no real earnings or profit potential. To counter this problem, many investors prefer to buy a company based on a multiple of earnings. They basically estimate the earnings for the next few years and ask how much that income stream is worth to them. The difficult part can be projecting what will happen in the future giving new competition, geographic/market changes, supplier price increases, etc.
Warren Buffett uses what’s called a discounted cash-flow analysis. He looks at how much cash the business generates each year, projects it into the future and then calculates the worth of that cash flow stream “discounted” using the long-term Treasury bill interest rate.
When pricing your business for sale, intangible assets – such as people, knowledge and marketplace position – can be even more important than tangible property.
Brands can be valued using three traditional valuation approaches: cost, market and income.
• The cost (or cost of creation) approach relies on calculating what it would cost another business to duplicate a given asset today. This can be done using an estimation of current costs or by calculating the present value of all historical expenses of creating the brand.
• The market approach focuses on past sale transactions of brand names. This may only be possible if you can identify a brand that’s comparable to your brand name and use it as a proxy. This is often considered the most reliable valuation method for a brand.
• The income method measures the future benefits (such as sales, profits or cost savings) that the intangible asset will bring to a business, the timing of the receipt of those benefits and the length of time that the business will receive those benefits. A variation of this approach is to calculate and capitalize the profits generated by your business with the strong brand name that are in excess of a similar “unbranded” business.
Valuing your loyal customer base is another intangible asset that you must consider. Generally, the best method to valuing a customer base is to segment your customers into categories based on characteristics that drive profitability. For example, frequency and dollar amount of purchases or longevity of relationship may be pertinent metrics. A lifetime customer value may be calculated as the present value result of the average profit per purchase multiplied by the number of purchases per period multiplied by the length of the relationship. Beyond simply helping you determine a value for your customer base, it will also help you identify the most profitable customers in your current business mix.
Surveying customers for the perceived quality and customer affinity toward your brand may also provide data necessary to support your demand for a premium sales price. Strong customer loyalty and a diverse customer base will go a long way toward setting your business apart from other options that buyers might be considering.
Another factor to consider is real estate that may be connected with your business. You may be able to get a higher price for the real estate if you sell it separate from the business. However, that all depends on how crucial your location and current facility is to the continued success of the business. If location is critical, you wouldn’t want to sell the property without understanding the effect on the business.
It is always important to understand exactly what the buyer wants to purchase. Some want to buy only the assets/liabilities. Others want the stock of the corporation. Each option has different tax consequences. Many buyers like to buy assets, because they can usually write them up and thereby increase depreciation or amortization on the books, thus reducing future taxes. But sellers usually pay more taxes when they sell assets. Ask your accountant for an analysis of the difference. Then, make sure to use this information in price negotiations with potential buyers.
Many companies choose to use a business broker, similar to a real estate agent for building transactions. Brokers can help you find the right buyer and avoid pitfalls in the transaction. The downside is that they will take a percentage of the sales price. Make sure you find out first if the broker is working for the seller or the buyer. Also, check the references to find out if the broker has had success. Most reputable business brokers will also have someone in their office that is a qualified real estate agent too. Brokers know how to help you prepare your property to sell and can market your business easier than you can. They may help you develop the necessary documents to value or show your business in the best possible light.
No matter who is directing the process, you need to make sure to protect the privacy of negotiations with non-disclosure agreements. Your attorney should review these documents. After a letter of intent is signed between two parties, the buyer will typically begin a detailed due diligence inspection of the business. It is almost impossible to keep the pending sale hidden from employees at this point. But you at least want to do your best to keep it from being common knowledge in the marketplace. Buyers can conduct surveys of customers under the guise of general customer quality research.
If you decide to sell your company, here are a few tips to make sure the sales process goes well.
1.) Investigate potential buyers while they are investigating you. This will help you know how to negotiate with them, what are the real reasons they want to buy your business, and the ability of a buyer’s management team to work with your organization in the transition phase. Conduct face-to-face meetings with the senior managers of any likely buyer.
2.) Understand the tax implications of various pricing options. Do whatever you can to lower the tax hit to you as the seller. Your accountant must be involved very early in the process.
3.) Turn everyday management of the company over to other top executives within the firm. As the owner, you need to make the sale of the business your full-time job. This will also help ensure that your company is ready to be sold because someone other than the owner knows how to run everything.
4.) Bring in outside help that will steer the process. This includes a business broker, an attorney familiar with mergers and acquisitions, your CPA, etc.
5.) Limit the access of potential buyers to your customers. Make sure that a non-disclosure agreement requires that the buyer gets your permission before contacting customers. While you don’t want to hinder a sale, you also don’t want your customers to jump ship if they learn a sale is pending.
6.) Be ready to stay on as a consultant for 1-3 years. This will be harder than you anticipate because you won’t be able to make a clean break with your business. You will have to stick around a while and muzzle your tongue while the new owner puts his mark on the operation. Most savvy buyers won’t purchase a business without some assurance that the former owner will provide this type of service.
7.) Avoid business brokers that don’t have a proven track record or guarantees you a high price. No broker can provide a firm guarantee other than a top-notch effort. Also, be suspicious if the broker wants a significant or total fee paid upfront.
8.) Sell when the timing is right. You may have to wait for the market to turnaround although you might find that a downturn is a good time to sell if you are willing to take a little lower price. Many companies with excess reserves look to acquire market share during economic downturns.
9.) Always run your business as if you want to sell it in six months. This will make sure that you will be ready to sell when the time is right. If not, you may miss out on the best price because it takes you too long to get everything just right.
10.) Plan for the closing, the final meeting when you transfer the business. Make a checklist of all the documents you will need to bring with you. Be ready to provide all details including day-to-day stuff like keys and passwords. The smoother the process, the more relaxed both you and the buyer will be.
