Your How-To Guide for Buying A Small Business: Small Businesses for Sale!
Buying A Small Business can give you the opportunity to take over an established operation rather than build one from the ground up. But a successful purchase requires more than finding a business for sale.
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The Complexities of Business Valuations
Many buyers and sellers are not aware of the complexities that go into appraisals for businesses. To get the most accurate results, a business needs to be looked at from a variety of angles. When completing a business valuation, we look at everything from comparable businesses to EBITDA. There are a lot of nuances involved that are customized depending on the business at hand. Without looking at a wide range of factors, you could accidentally get less for your business than what it’s really worth.
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What Will Be Important for Your Buyer?
When you’re selling a business, part of the fair market value of your business relates to benefits that your buyer will receive. Obviously, your valuation will include factors such as market share and profitability that a buyer will enjoy. But there are also less obvious factors. For example, is there potential for the business to expand beyond its current niche? What is the competition like? What about access to customers?
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Current Trends
Also brought into consideration should be trends that will impact the business. These trends could be everything from trends in technology to economic or social changes. In some cases, business trends might make a business much more valuable. For example, due to the recent pandemic and fast adaptation of online conferences, companies that integrated video conferencing had a major edge over those that did not.
When business owners are aware of emerging market trends, it allows them to develop new offerings to meet current demand. In turn, this can boost business growth and increase a business valuation.
The Workforce
Recent workforce issues have definitely impacted the value of businesses across the board. If you have a strong, highly trained and dependable workforce, it will help to increase the value of your business. If your staff members are customer-facing, positive customer experiences will drive revenue growth. Further, buyers will feel more confident buying a business with a reliable roster of employees.
There are many questions that will affect your buyer and those should be considered in the price you ultimately decide upon. The savviest business owners are always thinking about trends in society and how to work with them to strengthen the value of their business. They will also consider the decisions made by their competitors and how they impacted their businesses for better or worse.
Copyright: Business Brokerage Press, Inc.
The post The Complexities of Business Valuations appeared first on Deal Studio – Automate, accelerate and elevate your deal making.
The Complexities of Valuations
A lot of training and experience goes into good valuations. A variety of complex factors are involved. Plus, there are certainly some subjective elements. That means that one professional’s valuation may be different from the next. Let’s take a look at some of the factors involved when it comes to achieving an accurate valuation.
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Intellectual Property
Determining the value of IP or other intangible assets can be difficult. If the business in question has trademarks, copyrights, and patents, it can be far more challenging to properly assign a value.
Products and Services
As it turns out, businesses that only offer one product or service are far more difficult to analyze. If a company has a lot of product diversity, a professional will typically assess a higher value. The same is true for companies that have only one or two key customers. A lack of customer diversity can bring down overall values.
Employee-Owned Companies
If a company is partially or completely employee-owned, it can lower its marketability. Many company owners do not realize that employee stock ownership plans (ESOP) can change its overall value.
Life-Cycles and Supply Chains
In some cases, a business is nearing obsolescence due to advancements that have taken place. We often see this in technology companies. It should come as no surprise that if a business is near the end of its life cycle, this will raise potential issues during the valuation process. On a similar note, could the business be susceptible to supply disruptions? If a business is assessed as vulnerable in that area, it could also lower an overall valuation amount.
Accuracy of Data Received
Of course, the person handling the valuation must rely on the accuracy of the factual information they receive. If the numbers are off, the valuation simply cannot be as accurate.
These are just a few examples of the list of issues that can impact a valuation. If you’re trying to get an idea of what your business may be worth or if you‘re wondering what factors might impact your valuation, reach out to our team. We’d be happy to discuss this in greater detail.
Copyright: Business Brokerage Press, Inc.
The post The Complexities of Valuations appeared first on Deal Studio – Automate, accelerate and elevate your deal making.
Embracing Technology to Boost Your Business
Forbes author Keith Gregg’s, February 8, 2019 article, “Using Tech to Enhance and Sell a Business,” has a range of interesting ideas that business owners should explore and embrace. Gregg looks at three big ways that business owners can use technology to help them get the most out of the sale of the business. He explains how important it is to address these three areas before placing your business on the market.
Table of Contents:
Upgrading Systems
The first tip Gregg explores is to upgrade systems. Upgrading systems can be particularly important for attracting younger buyers. It is common for businesses to be successful without proprietary technology or procedures, but that doesn’t mean that technology should be ignored.
Important information should be digitized, as this data will be vital for the new owner to grow the business over the long haul. Incorporating software that can track and analyze data across the business is likewise valuable. Using software, such as customer relationship management and financial management software, will showcase that your business has been modernized.
Business Valuations
Determining the value of your business can be tricky and laborious. Gregg recommends opting for a business valuation, as he feels, “business valuation calculations can remove much of the guesswork from the process.”
You should expect a business valuation calculator to include everything from verified data on comparable business deals, including gross income and cash flow figures and more. There are even industry-specific calculations that can be used as well. The main point that Gregg wants to convey is that business owners should use tangible and proven data to sell their businesses. Like upgrading systems appeals to younger buyers, the same holds true for using verified data to sell.
Take Advantage Of The Digital Marketplace
Gregg’s view is that perhaps the single greatest technology for business owners to leverage is that of the digital marketplace. Sites that link businesses with prospective buyers can help to streamline and expedite the sales process. Through such sites, it is possible to go deeper than a specific industry and even explore sub-sectors, thus enhancing the chances of finding the right buyer.
Technology can be used to help sell businesses in a variety of ways. An experienced and proven business broker will leverage a whole range of tools to assist business owners when selling their businesses. When you opt for a proven business broker, you can expect to receive offers from serious and vetted buyers and, in the process, save a great deal of time while maintaining confidentiality.
Obtaining a Fair Market Value for Your Business
Divestopedia published a rather insightful article, “Letting the Market Bridge the Valuation Gap.” In this October 2018 article, Dave Kauppi dives in and explores how fair market value can be used as a way for business owners to “bridge the gap between the valuation they feel they deserve and that which they’re likely to receive.” This, of course, increases the chances of a deal actually taking place. Let’s turn our attention to some of the key points in Kauppi’s informative article.
Understanding the Reality of Selling a Business
One key point is that only a low percentage of businesses actually sell on their first attempt. The article points out that a mere 10% of businesses that are for sale are actually sold three years later; this is a simply brutal fact. Few facts, if any, help underscore the value of working with a business broker more than this point. Selling a business can be difficult under even the best of circumstances. The process is complex, and most sellers have never actually sold a business before.
Divestopedia believes that it is critical for business owners to have realistic expectations regarding valuation. As the article points out, the market doesn’t care “how much money you need for retirement,” or how much you’ve invested.
Four Points to Consider
According to the article, it is important that business owners understand that a few business characteristics will ultimately drive the sale. There are four key factors to consider: contractually recurring revenue, durable competitive advantage, growth rate and customer concentration.
There is a lot packed into these four points, but here are a couple of big takeaways. In terms of customer growth, if a large percentage of your business is derived from a single customer, then that is going to be seen as a problem. As Divestopedia points out, if your company is dependent and partially dependent on a single customer, then you can expect a lot of pressure for you, as the business owner, to stick around a lot longer to ensure that this key customer isn’t lost. If intellectual property, such as software, is involved, then things can get even more complex. In the end, determining value in technology-based companies can be more challenging.
In the end, working with a seasoned business broker, one that understands valuation and how best to get there, is a must. You want to receive the best possible price for your business. An experienced business broker will help you understand how to navigate the complex process of determining a price. However, and most importantly, a business broker will help you achieve a fair market value, so that your business doesn’t remain unsold for years.
Checklist for Valuation
1. Start with the business
– Value Drivers: Size, growth rate, management, niche, history
– Value Detractors: Customer concentration
Poor financials
Outdated M&E
Few assets
Lack of agreements with employees, customers, suppliers
Poor exit possibilities
Small market
Potential technology changes
Product or service very price sensitive
2. Financial analysis: Market Value – comparables
Multiple of Earnings – based on rate of return desired
3. Structure and terms: 100% cash at closing could reduce price 20%
4. Second opinion: Even professionals need a sounding board
5. Indications of high value:
– High sustainable cash flow
– Expected industry growth
– Good market share
– Competitive advantage – location/exclusive product line
– Undervalued assets – land/equipment
– Healthy working capital
– Low failure rate in industry
– Modern well-kept plant
6. Indications of low value:
– Poor outlook for industry –
foreign competition
price cutting
regulations
taxes
material costs
– Distressed circumstances
– History of problems – employees, customers, suppliers, litigation
– Heavy debt load
What Is a Company Worth?
This question can only be answered by addressing other related questions, specifically: Who’s asking and for what purpose?
From the perspective of the owner, prospective buyers, the IRS, lenders and divorce & bankruptcy courts, the value of a business for purposes of a sale, estate planning, orderly or forced liquidation, gifting, divorce, etc. can be vastly different.
Intrinsically tied to the various purposes of valuation are numerous definitions of “value.” Here are a few examples:
Investment Value – The value an acquirer places on a business based on a future return on investment determined by assessing past and current performance, future prospects, and other opportunities and risk factors involving the business.
Liquidation Value – The value derived from the sale of the assets of a business that is closed or expected to be closed following the sale.
Book Value – Book value is the difference between the total assets and total liabilities as accounted for on the company’s balance sheet.
Going Concern Value – Used to define the intangible value which may exist as a result of a business having such attributes as an established, trained and knowledgeable workforce, a loyal customer base, in-place operating systems, etc.
Fair Market Value
For the purpose of this article, the focus will be on transaction related valuations. Fair Market Value (“FMV”) is the most relevant definition of “value” and is of the most interest to business owners. The more knowledge business owners and prospective buyers have about the valuation process, the more likely they will come to an agreement on a purchase price.
FMV is the measure of value most used by business appraisers, as well as the Internal Revenue Service (IRS) and the courts. FMV is essentially defined as “the value for which a business would sell assuming the buyer is under no compulsion to buy and the seller is under no compulsion to sell, and both parties are aware of all of the relevant facts of the transaction.” IRS Revenue Rule 59-60 lists the following factors to consider in establishing estimates of FMV:
1. The nature and history of the business.
2. The general economic outlook and its relation to the specific industry of the business under review.
3. The earnings capacity of the business.
4. The financial condition of the business and the book value of the ownership interest.
5. The ability of the business to distribute earnings to owners.
6. Whether or not the business has goodwill and other intangible assets.
7. Previous sales of ownership interests in the business and the size of ownership interests to be valued.
8. The market price of ownership interests in similar businesses that are actively traded in a free and open market, either on an exchange or over-the-counter.
What is Goodwill?
An important element of value, when it exists, is goodwill. The IRS defines goodwill in its Revenue Rule 59-60, stating, “In the final analysis, goodwill is based upon earning capacity. The presence of goodwill and its value, therefore, rests upon the excess of net earnings over and above a fair return on the net tangible assets. While the element of goodwill may be based primarily on earnings, such factors as the prestige and renown of the business, the ownership of a trade or brand name, and a record of successful operation over a prolonged period in a particular locality, also may furnish support for the inclusion of intangible value. In some instances it may not be possible to make a separate appraisal of the tangible and intangible assets of the business. The enterprise has a value as an entity. Whatever intangible value there is, which is supportable by the facts, may be measured by the amount by which the appraised value for the tangible assets exceeds the net book value of such assets.”
Valuation Approaches and Methods
Exploring valuation techniques requires an understanding of the tools available. Which tools are utilized depends in part on the purpose of the valuation and the circumstances of the subject company. Generally there are several approaches to valuing a business. Within these approaches, there are several different methods. Listed below are the three major approaches along with some examples of specific methods that fall under each category.
• Income Approach
Discounted Cash Flow Method
Single Period Capitalization of Earnings Method
• Market Approach
Comparable Publicly Traded Company Analysis
Comparable Merger & Acquisition Analysis
• Asset-Based Approach
Adjusted Net Asset Method
Excess Earnings Method
All of the above methods and approaches are frequently used in business valuations.
Normalizing the Financial Statements
Before the approaches and methods above can be applied, it is necessary to analyze and normalize both the income statement and balance sheet of the business for the current and past periods selected to form the basis of the valuation.
• Normalizing the Income Statement
Normalizing the Income Statement generally entails adding back to earnings certain personal expenses, non-recurring and non-cash items. Examples of these “add-backs” could include depreciation, amortization, auto, boat and airplane expenses, one-time extraordinary expenses and other excess expenses such as owner’s salaries and family member’s salaries that are above fair market value, travel and entertainment, bonuses, etc. Owners usually tend to be extremely liberal when normalizing the income statement in order to bolster earnings, which can artificially inflate valuation. Each item must be carefully analyzed and scrutinized to insure that the normalization process is credible.
• Normalizing the Balance Sheet
Normalizing the Balance Sheet includes adjustments that eliminate non-operating assets and other assets and liabilities that are not included in the proposed transaction, and therefore the valuation. The book value of the assets will be adjusted up or down to reflect their fair market value. Inter-company charges will also be eliminated. Inventory may be adjusted upward or downward based on prior accounting procedures and/or obsolescence. Accounts receivable may also require an adjustment based on an analysis of collectibility.
Relevant Terminology:
EBIT – An acronym for earnings before interest and taxes
EBITDA – An acronym for earnings before interest, taxes, depreciation and amortization.
Capitalization Rate – Any divisor that is used to convert income into value. This is generally expressed as a percentage.
Discount Rate – The rate of return that is used to convert any future monetary gain into present value.
(Note: when determining FMV, the earnings stream selected to be capitalized or discounted should be normalized.)
Summary
Even with all the terminology and definitions discussed above, the answer to the original question has not yet completely been answered: What is the company worth?
The value driver of a business is the ability of the entity to generate future cash flow or earnings. Business appraisers will assign an appropriate capitalization rate (or multiple) to a selected earnings stream to derive an overall value for a business. The value of the net assets of the business will be compared to the cash flow valuation and may be adjusted upward or downward. For example: if the earnings based valuation is less than the net asset value, an upward adjustment may be in order. Conversely, if the net assets are negligible, a downward adjustment is more likely to occur.
Many appraisers typically use a common range of multiples to arrive at a “ballpark” indication of value (for example, 4 to 6 times EBITDA). While this approach is commonplace, an in-depth valuation of the subject company will produce a more accurate result. There are too many intangible factors to be considered to rely solely on the capitalization of earnings. Of course, the ultimate value of a company will be determined by the marketplace, which can greatly differ from a seller’s expectation, as well as the expectations of potential acquirers.
It is not uncommon for business owners to have an inflated sense of value of their company. This could be due to a variety of factors including emotional attachment to the business, unwillingness to accept the impact of the risk factors of the business, outside influence from previous market conditions, incorrect conclusion of normalized earnings, comparable transactions, etc. Conversely, acquirers often undervalue businesses. In their quest to “buy right” they often end up paying a lower multiple for a company with serious negative factors, while passing up on higher multiple opportunities, which, due to the quality, are actually better buys.
Valuation is a complex process. Owners and buyers will be well served if they rely on professional advisors such as their accountants, business appraisers, intermediaries or investment bankers.