What’s My Business Worth?
by Steven Wasser
Steven Wasser facilitates the Executive Peer Group at Upstate Capital
In a simple world, the answer would be simple: your business is worth a multiple of earnings. Even with this approach, questions would remain. What measure of earnings should be used? After-tax profits? Operating income? EBITDA? And what is the right multiple?
The Financial Buyer
There are two basic types of buyers for a business. Each has a different way of valuing your business, and each usually has a different set of requirements and expectations. The typical financial buyer is a private equity firm. Generally, such firms have a clearly spelled out set of criteria on their web site detailing the type and size businesses in which they will invest. A private equity buyer is likely to be very numbers driven. You are likely to spend a lot of time negotiating what the real or “recast” profits should be, and what an appropriate multiple of those profits should be for valuation purposes. The financial buyer usually wants to know that there is a competent management team that will remain on board after a deal closes. If you are the bulk of the management team and want “out” after a transaction, you may have trouble concluding a deal with a financial buyer.
Financial buyers are making an investment with an expectation of a limited duration before they do something to cash in. The time frames vary but, in my experience, private equity firms like to flip their investment after five to seven years, or take the investment public. Many financial buyers will use the borrowing capacity of the business to pay you for the business. In that case, the buyer pulls as much cash as possible from the business, perhaps by selling off certain assets, and then loading up the business with debt. This strategy makes sense for the buyer but is not always good for the business.
Some financial buyers may also have strategic motivations – for example, a private equity firm might be doing a roll-up in a particular industry and needs that final piece to complete the roll-up, hence the strategic component. If so you are in luck. Strategic buyers generally pay more than financial buyers because there is something about your business that they value above and beyond the profits or cash flow.
The Strategic Buyer
Strategic buyers may, like financial buyers, use earnings multiples as one way to consider the valuation of your business. The multiple they are willing to pay is likely to be higher than what a financial buyer would pay. Here are some of the valuation consideration a strategic buyer might use in negotiating for your business.
Earnings Multiple. There are multiple measures of profit. The typical measure for public companies is the Price to Earnings ratio, or PE, which looks at the stock price compared to the earnings per share which, in turn, are based on after tax earnings. In private transactions the most common earnings measure is EBITDA – earnings before interest, taxes, depreciation, and amortization. It’s a quasi-cash flow metric. To calculate the value of a business the approach is to multiply EBITDA times some multiple. That multiple depends on numerous factors. For a profitable business it might range from 3x to 10x. Multiples vary depending on economic conditions and factors in your business. If you want a median number I’d say currently a smallish, profitable, private business with a niche position might sell for 6x EBITDA to a strategic buyer.
Intellectual Property (IP). If your business has something very special that no one else has, and which is difficult for competition to replicate, then you can throw the EBITDA multiple out the window. For example, in a mature business a trademark like Polaroid or Kodak might have more value than other assets which might be generating losses. On February 13, 2019 The New York Times published an article entitled, “Can Big Science Be Too Big?” According to the research on which the article is based, “the smaller the research team working on a problem, the more likely it was to generate innovative solutions.” It’s become a pattern in the pharmaceutical industry, for example, for larger companies to cut back on their own drug development efforts and, instead, to rely on and acquire pharmaceutical products developed by smaller companies. IP includes technology, brands, and proprietary know-how. If your firm has one or more of these and, ideally, has protected them with patents, trademark registrations, or copyright, and the IP is valuable to the potential buyer, then you could be in a strong negotiating position.
Sales Volume. Some buyers are more interested in buying volume and market position, and will downplay if not ignore your company’s profitability or lack thereof. I was involved in searching for acquisitions in the cable TV market during a period when these companies were marginally profitable, if at all, and were capital intensive. At that time buyers in the cable TV market would value a smaller cable system based on multiplying a dollar value times the number of subscribers in the system.
Synergy. Synergy can be difficult to measure since it usually depends on something the buyer has that could strengthen the profitability of your business. If your company can complement a buyer’s geographic market or product line, or if your company’s products can be distributed through the buyer’s much broader distribution system, then you may have synergy (or the potential for it). However, the question may arise whether the buyer wants to pay you for what the buyer’s business will do for your business.
History. Look for transactions already concluded by your potential buyers. Can you get data on the price they paid through published sources or your industry contacts? Are there public companies whose valuation would be relevant? What’s different about your business? How would that difference be likely to impact the buyer’s valuation of your business?
Here are a few suggestions concerning the process of negotiating the sale of your business:
Self knowledge. Know why you are considering the sale of your business (for yourself), and be prepared to tell the story to potential buyers.
Intermediary. There are business brokers, financial advisors, and investment bankers who can assist in selling your business. I recommend you engage one for several reasons:
The fee you pay – roughly 5% – is what it costs to hire an expert. Besides, just like selling your house, when you don’t use a broker buyers tend to factor the absent brokerage fee out of the purchase price so you save nothing.
The intermediary will run interference for you and, to a degree, allow you to keep your eyes focused on running the business. They can also help you keep the emotions tamped down.
A good financial advisor will put together “a book” about your business and create a virtual data room that buyers will access during the various stages of due diligence.
Negotiations. I don’t care how well you know the potential buyer or what a great person you think she is. If you do not have actual multiple buyers or at least the perception that there are serious, multiple buyers, you will be unhappy with the outcome. Competition in the sale of your business works wonders.
Confidentiality. You might want to be open with your employees, but I strongly advise against it. Your employees do not control the process and all your openness will do is raise their anxiety level. You also don’t want word to leak out to the competition. Most likely you will need to bring your CFO and COO into the process, and possibly offer a deal completion bonus. Swear your executives to secrecy, and do not disclose the negotiations to others.
Due Diligence. Deals can easily fall apart during due diligence. In some cases the buyer discovers something that diminishes their interest in and willingness to pay for your business. In other cases an unethical buyer may simply be using the due diligence process to gain confidential information about your business or to re-trade the deal. A good financial intermediary is invaluable during the due diligence process.
You can try to establish the value of your business, but ultimately it’s the buyer whose valuation is determinative. Always keep the buyer’s interests and motivations in mind if you want their number and your number to converge.
If you’d like to be part of Upstate Capital’s Executive Peer Group, you can contact Steven at email@example.com, or Noa Simons, the Executive Director of the Upstate Capital Association of New York, at firstname.lastname@example.org for more information and an application.
Steven Wasser has been involved with CEO peer groups for 20 years, including 10 years as a member of Vistage and 10 years as founder of a self-facilitating, cooperative group. He has an MBA from Harvard Business School, has worked as a management consultant and owned Verne Q. Powell Flutes, Inc., the Stradivarius of the flute world, for 30 years. Wasser has also taught entrepreneurship, strategy, and leadership to undergraduate and graduate business students.
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