What’s Your Business REALLY Worth?
A recent article in INC magazine titled”Street Smarts,” by Norm Brodsky (his column is worth the price of the magazine) addressed the subject of the title above. However, in the very first paragraph of the article, Mr. Brodsky stated, “Unfortunately, most of them [business owners] have grossly inflated notions of what their companies are worth.” Mr. Brodsky is not one to mince words. Some of his examples were: “One company had lost money on sales of about $60 million, and yet its owners thought it was worth between $50 million and $100 million … Another company had a net profit of less than $335,000 on sales of about $6.5 million – and still the owners somehow came to believe it was worth between $100 million and $200 million.”
Mr. Brodsky feels that the reason for this is “… our egos can get us in trouble when it comes to putting a dollar value on something we’ve created. We generally take the highest valuation we’ve heard for a company somewhat like ours – and multiply it.”
He goes on to point out that prospective acquirers are more concerned about profits, especially Free Cash Flow, than sales. Too many company owners use some rule of thumb based on sales. He also points out that company owners tend to use a comparison of a similar business across town that sold for some multiple of sales and then apply it to their company. There are so many variables of how sales (and subsequently earnings) are generated that no two companies are ever alike.
Business owners tend to forget the negatives of their business; e.g., sales from just a few customers, lack of contracts with customers and suppliers, lack of product diversity, out-dated equipment, etc. Also, as Mr. Brodsky points out, “Before you try to sell, make sure you know what buyers want.”
Turning to another expert voice, here is some good advice from Allen Hahn, Senior Vice President of Valuation Research Corporation: “The level of EBIT or EBITDA used for negotiating a purchase price is the ‘normalized’ level that will be available to the new owners from the assets acquired. Often times this requires elimination of unusual, inappropriate or non-recurring expenses. Buyers will typically consider a company’s last twelve months of financial performance. However, projected results may be more relevant if a structural change has recently occurred in the business (loss of a key customer, acquisition, etc.) that renders historical results less meaningful.”
What does all of this mean? It means that owners should disregard rules of thumb based on what the company across town sold for; it means that owners should not use a multiple based on what the business did four or five years ago, or what they think the business will do next year.
Business owners should first put their egos aside, then look long and hard at the company’s cash flow, realistically assess the negatives (and positives) of their business and “make sure you know what buyers want.”
Is Your Company Hiding an “Orphan”?
Does your business have an orphan product or service that is doing okay, but doesn’t seem to fit into your core business? Many companies, private equity groups and even some individual buyers are seeking product lines to augment existing ones, or even to build a business around. Here are just a few of the reasons why a company might want to divest itself of a product line or even a particular service:
- It may not be a good fit for the parent company, thus diffusing efforts that could be placed into the core business.
- Because it is an orphan, it is a distraction.
- It man be a break-even side business that with a full-time effort could be profitable, but resources are better devoted to the core business or service.
- The money received could be used to expand the core business or fund some improvements that are not currently budgeted.
Certainly, there can be some disadvantages in allowing the adoption of an orphan – on both sides. There is the all-important people issue. Some valuable employees may be attached to the product line – and may go with the sale or decide to leave and move on. This can negatively impact both sides of the transaction. It can also have a negative impact on the selling company’s employees when the selling or purchasing company releases employees. There are cultural issues to consider. The product may be a more important part of the selling company than management thought. It may have played a role in selling other products or services. The distribution channels may play a role in other product lines. It is important for management to consider whether the orphan is really an orphan before selling it off.
On the plus-side for the acquiring company, the addition of the product line may be a perfect fit for their existing distribution chain. The brand name acquired may provide name recognition to some existing products. The new product line may be able to be manufactured with only a minimum increase in employees and plant capacity.
The purchasing company may have a difficult time establishing a price. It may seem easy to look at the sales and the cost of sales, but the cost of sales may not include an allocation for rent, and for support services such as legal, accounting, corporate oversight, etc. Some part of the product may be manufactured on equipment used for other products, warehousing may be shared, and parts used in other products. Many acquisitions are sold with a form of licensing agreement so the selling company receives a royalty or license fee representing a small portion of the sales of the acquired product line.
Company management is prone to think of only selling the entire business, a division or subsidiary of the company, when a sale of a product line may be an excellent solution. The decision to sell a product line or service may solve a host of problems and perhaps even eliminate the need for sale of the entire business. As Fortune magazine has written, “Companies once obsessed with cutting costs are now urgently trying to boost sales – with new products, new services and new markets. The surest – and ultimately cheapest – way to increase your total sales is to persuade your existing customers to buy more products.”
When Is A Company In Trouble?
Companies can be in trouble or headed for it for many reasons. However, most of them can be linked to one or more of the following:
• Lack of proper focus
• Poor management
• Poor financial controls
• Loss of key employee(s)
• Loss of important customer(s)/client(s)
• Not keeping up with technology
• Quality control or other operating issues
• Legal or governmental issues
• Target market change or shift
• Competition
Unfortunately, by the time a business owner realizes that the business is in trouble and recognizes why, it may already be too late. The obvious solutions are to either fix it or sell it. The decision should be made quickly, since time may be of the essence.
Unfortunately, too many owners of privately held businesses wait too long. A decision to sell should be made when the business is doing well, not when it is in trouble.
Now may be the time to check with a professional intermediary to see what you can do to prepare your business for sale.
How Does Your Company Rate?
Valuation of private companies is much more subjective than public companies because there is no free trading marketplace for the private companies’ stock. Just like a champion Olympic figure skater, the performance has to be flawless. Take a look at the following check list – see if the target company rates near perfect (on a scale of 1 to 10 – 10 being best):
• Stable Market
• Stability of Earnings Historically
• Realized Cost Savings After Purchase
• No Significant Capital Expenditures Herewith
• No Significant Competitive Threats
• No Significant Alternative Technologies
• Large Market Potential
• Reasonable Market Position
• Broad-based Distribution Channels
• Synergy Between Buyer and Seller
• Sound Management Willing To Remain
• Product Diversity
• Wide Customer Base
• Non-dependency on Few Supplier
Mistakes Sellers Make
• They neglect to run their business during the sales process. – The owner of a business with sales under the $20 million range can get so involved in the selling process that they neglect the day-to-day operation of the business.
• They don’t understand the “real” value of their business. – A business may actually command a higher price than the value determined by an appraiser. The business may be worth more than the sum of its parts. A professional intermediary, along with other advisors, can answer the question of real value and help determine a “go-to-market” price.
• They aren’t flexible in structuring the transaction. – In many cases, how the deal is structured is more important than the price or terms.
• They are not looking at the business from a buyer’s perspective. – Buyers may look for different aspects of a business than those the seller looks for. For example: growth potential, management depth, customer base, etc.
• They start with too high a price. – Sellers obviously want to maximize the price they receive for their business, but today’s marketplace is difficult to fool. A good buyer may just elect to pass because of an overly aggressive starting point.
• They are impatient. – Sellers have to understand that it can take 6 to 18 months to find a buyer and proceed through the sales process, which includes due diligence, the legal and accounting issues that must be handled, and ultimately the closing. However, on the flip side, the longer the deal drags, the more likely it is to fall apart. As the saying goes: Time is of the essence!
• They have insufficient or inadequate documentation. – Sellers should have current real estate and equipment appraisals at the ready along with any documentation a buyer might want, such as projections, business forecasts and plans, and environmental studies. Having all the documentation and financial records readily available will not only speed things along, but might also provide for a higher price or, even more important, save the deal.