As a business owner considers placing his or her company on the market, ascertaining the proper value for the company is critical. Too often the owner assigns an unrealistic and unachievable arbitrary value then proceeds to the sale process only to be disappointed with the market’s response. As a result, the asking price is reduced several times. During this unfortunate period buyer prospects and valuable time is lost.
In truth, a company’s value is determined by a compilation of factors such as the company’s sales, earnings, performance, market outlook, personnel, net book value and fair market replacement value of equivalent operating assets. But it can also be influenced by intangible assets like the company’s image, reputation and goodwill.
There are several approaches to valuing your business.
Balance Sheet Value
There are several balance sheet valuation methods, including adjusted book value, book value and liquidation value. The adjusted book value is determined by revising the asset’s book value to reflect the cost it would take to replace the assets in their current condition. This method requires the total values to be offset against the sum of the liabilities.
The book value considers the figures from the company’s financial records, as depreciated at the time of the sale. The book value can pose some difficulties for sellers, particularly if the seller has depreciated the assets too much to gain prior tax advantages.
The liquidation value is the amount that could be realized if all assets – equipment, furnishings and inventory – were sold separately. This value is typically much lower since it doesn’t consider a company’s intrinsic value.
Income Approach
The income approach takes into consideration the company’s level of earnings using a capitalization rate, discount rate or multiplier. Several income approach methods are frequently used. Each method requires a level of earnings and a conversion factor to translate the earnings into a company value. Selecting the proper level of earnings – after-tax, pretax, discretionary or cash flow – and matching it with the proper conversion factor – discount rate, cap rate or a multiplier – is critical to calculating a reasonable value.
Market Approach
The market approach sets a value based on the values of other businesses that have been sold. Setting the market value involves researching the sale prices for similar businesses in a geographic area. In some cases, however, finding a company that is similar in many ways to your company may be difficult.
Whatever your goal, you want a good advisor to help you assess the value of your company. Question your advisor on the effects of deal structure and how multiples are used. A business owner should never accept a computer-generated valuation or a one-size-fits-all approach when selling the business. And don't be impressed by the person who presents the highest value – you may only be setting yourself up for failure during the sale process.
The typical business owner will only sell a business once. Understanding the complex process involved will help produce the best results. But don’t fall prey to the myths that can derail or seriously affect a potential sale.
Myth #1 – I Can Sell It Myself
Many owners believe they’re qualified to sell their business without professional assistance. Many owners are entrepreneurs and the key salesperson for the company. But selling a business is not like selling a product or service.
If you’re looking to sell on your own, confidentiality is lost. If word of a potential sale gets out, there are definite risks of losing clients, employees and favorable credit terms.
Do you really have the time to run your business and compile marketing materials, advertise, screen buyers, give tours and facilitate due diligence?
When you’re looking to sell you want to put even greater emphasis on running your business, boosting your sales and not taking on new challenges.
Myth #2 – I’ll Sell When I’m Ready
Certainly, an owner wants to be sure he or she is mentally and emotionally prepared to sell. But personal readiness is just one factor. Economic factors can have a significant impact on the sale of a business.
Sale prices can be affected by industry consolidation, interest rates, unemployment and many other economic measures. Talk with a professional and aim to sell when your personal goals and market conditions align.
Myth #3 – I Know What it is Worth
Some owners will base the company value on what they need for retirement. Others will tell you they want $100,000/year for “sweat equity.” Still others utilize industry multiples.
A third party valuation is a good idea for anyone seriously considering the sale of their business. An outside valuation will include a thorough analysis of the business and the market it operates in. This will provide a solid understanding of the company’s growth potential, not some vague industry average.
Myth #4 – It’s Like Selling a House
Preparing to sell your house may take a few weeks, then you want to get the word out to everyone that the house is on the market. Once you get a satisfactory offer, you sign on the dotted line, turn over the keys and move on.
Selling a company is much more complex. A successful business sale usually requires a great deal of pre-planning, at least a year and maybe as long as three years to drive sales, develop key staff, document the operations and control expenses.
The average house will sell in less than four months, while the average business sale is nine months to a year.
Even after the business is sold, the seller can be expected to put in at least a few months, and possibly years of transition time, helping to make the new owner a success.
Sound sale strategies will bring you the optimum price the market will bear. Go to market with realistic expectations by getting a professional valuation and using a professional business broker or intermediary.
Sure you want a big payoff, but when it comes to selling your business, money should not be the only consideration. You don’t want just any buyer, you want the best buyer. With the market we’re now experiencing, many sellers are getting multiple offers, but the buyers they choose aren’t always the ones offering the most money. Would you consider a lower price for a buyer that fits the company’s culture? Would you consider an offer that’s a million dollars lower if it meant the difference between years of seller financing and cash at close?
It’s common for deal structures to include a variety of options which must be carefully considered and evaluated, long before you get to the negotiating table.
You may not realize it, but you’re positioning and negotiating from day one of a sale. Be sure your priorities are well thought out or you might give a buyer the wrong impression which can have serious consequences. There aren’t any wrong answers – your priorities should be what you feel is important.
A prospective buyer may ask how long you’ll stick around after the sale and you may casually respond that you’ll be around as long as needed. Then you find out that the buyer is thinking about a two year transition when you and your wife had been discussing a potential move to Florida.
Something like that could blow up a deal. Had your initial response been that you would be around three to six months and then could provide consulting services from Florida, the buyer would not be counting on long-term support. Remember, it’s always easier to give the buyer more than expected than take something away.
As a seller, there are some common decisions you may have to make:
Financing: Do you prefer a higher offer with some seller financing or a lower offer with cash at close?
Transition: Are you looking for a quick exit? Does the buyer expect a lengthy transition?
Employees: Sellers are often very protective of their employees. Will the buyer relocate or replace staff?
Ownership: Are you looking to maintain a minority stake for yourself or your family?
Legacy: Most sellers don’t want to cash out and watch the company erode. Ten years from now they want to look at a successful business that they had a hand in building.
Property: Is the buyer interested in your building? Some sellers prefer to keep the property and draw rental income. If the buyer doesn’t want your facility, how soon can you fill it?
Trust: Do you trust the buyer? Some sellers will pass up higher offers to work with a buyer they feel better about.
Even if you know your preferences, you may not get everything you want when making a deal. A reputable business broker or intermediary will be sure that the right questions are asked to help you organize your thoughts, review your priorities and understand what the market will bear. In the end, you’ll find yourself in a better position to negotiate and close the deal—without sacrificing your goals.
If you’re looking to sell a business, it’s critical to look at the value of the business. But a typical business really has two values. The “academic” value is the one determined by a professional business valuation. The other is the “true market” value. The academic value arrives at with a formula based on the firms’ hard assets, cash flow, industry averages and multiples. The fair market value also takes those items into consideration, but then considers what buyers are really willing to pay.
For many small and mid-sized businesses hard assets like equipment, vehicles, land, buildings, and inventory may be limited. For some small businesses there may be no hard assets at all. Instead, their value is based on intangibles like employees, business processes, customer lists, location and business relationships.
To maximize the fair market value of your business, it’s vital that you capitalize on those intangible assets.
Develop key employees.Buyers generally aren’t interested in paying a premium if the business relies on you for its success. Remember to delegate responsibility to key employees and involve your key staff members in the decision making process. Demonstrating that your company’s success is reliant on your capable, well-trained employees – not just you – will pay off at the time of sale.
Document what you do. Be sure that job descriptions, operation processes, and strategic plans are documented. Documented records and plans give a buyer greater comfort that he or she will be able to emulate your successful growth and will help your buyer obtain financing. Also, be sure to keep business records like sales and expense reports, internal profit and loss statements/balance sheet, and tax returns clean and well-organized.
Build relationships. Name recognition, customer awareness and your reputation are all part of your business value. Even if your company doesn’t have many hard assets, your relationships are key. Consider diversifying both supplier and customer accounts.
Improve cash flows. A potential buyer wants to see the “true cash flow.” And, of course, in the business world cash is king. Be sure you are driving all income to the bottom line.
Review your assets. Sell off or dispose of unproductive assets or unsalable inventory. Remove or buy off any assets that are primarily for your personal use.
Find and build your niche. You don’t have to be everything to everyone. Buyers will pay a premium for a niche that has barriers to competitive entry.
Remodel, clean, and organize. What’s the first thing anyone does when they put their home on the market? They spruce things up and make sure everything is in its right place. Yet, in business, that’s rarely considered. A well-maintained facility will get the best price. Even businesses that lease space can benefit from a thorough cleaning and organization to convey a feeling of quality and efficiency.
Keep these important intangible assets in mind if you’re looking to sell your business. They convey a value that financial statements alone do not. If you are looking to sell, make a plan. Start working on the intangibles well in advance of putting your business on the market. For many business owners, they reach a point where they burn out and psychologically retire early, before a sale is made. It’s important to work to keep your focus right until the sale is complete.
Finally, when the time to put your business on the market arrives, consider lining up key specialists who will help you make the most of the sale – an attorney, an accountant, and a business intermediary to name a few. Remember, you only have one chance to sell your business, so you want to do it right.