To build value you first need to know where your company performs best and where it is deficient. In short, your strengths and weaknesses from a buyer’s point of view. A detailed diagnostic of your company unveils those strengths and weaknesses, its value enhancers and risk considerations, the traits that are unique and highly valued and the threats to which your business may be vulnerable.

A thorough assessment begins with market research that includes a comprehensive analysis of industry trends and an in-depth review of your competition. From this assessment benchmark your company against other businesses of similar size that have sold in your industry or related markets. In identifying those elements where buyers paid premiums, be sure to consider the full spectrum of attributes. Much of the value of your business may be intangible and difficult to recognize.

It is important to have an objective versus subjective perspective or you may fail to recognize opportunities for enhanced value. While you know your business better than anyone else does, the only way to enhance value is to take an outside perspective. Careful analysis from professionals familiar with the M&A market is recommended in order to structure a value improvement plan based on the way buyers perceive value.

Recognize that buyers buy businesses only in part based on recent financial performance. The major portion, on average three-quarters of the value, is based upon the future potential and other characteristics of the business.

There are several “owner” related reasons why businesses sell for less than their potential. Read the rest of this entry »

After a career spent buying and selling companies, I’ve learned that the essence of a deal comes down to this simple fact:

A company is sold when its value is greater to the buyer than it is to the seller.

This obvious statement raises the more complex question: Why is the value of the same company different for the buyer and the seller? This can also be answered in a simple, though perhaps less obvious, statement:

Value is the future cash flows to the owner over time, discounted by the owner’s risk discount rate.

Now, this starts to get more complex. The values are different because the cash flows over time will be different for different owners, and because each owner has a different discount rate. In addition, the discount for the same owner will change over time.

Here are two examples from the owner’s perspective:

1. Think of a company owned by a relatively young person in his mid thirties. You don’t often hear of these owners selling their companies. Here’s why: for this owner, he expects to get a 30-year return of future cash flows. Plus, he will expect to grow those cash flows at a rate greater than inflation over the 30 years.Equally important, his discount rate for risk is low. His rate is low because he has a 30-year window to adjust and recover from the bad things that will happen along the way. He can weather a three-year recession and still be building value when the economy recovers. His health is good, so there is little risk that he will be forced to sell his company during a period of lower M&A valuations.
2. Now think of a company owned by a person in his sixties. His future income stream is really only three or five, or maybe seven years long. He cannot expect significant growth in that income stream in those few years. He is not prepared to make extra investment of time or money to accelerate growth. Even if he had an idea to stimulate growth, there is little time to implement it, it would have risk and the rewards may come after he is retired.The other piece of this owner’s equation is that his risk discount rate is much higher. His company faces risks daily from the economy, increasing taxes, regulations, new competitors, lost key employees and his own personal health. With a short time horizon to recover, this owner runs the risk of significantly diminished cash flow when it is time to sell. The inability to recover from all these risks put a high discount on future earnings. The combination of these two factors – cash flow and risk – is exactly why owners decide to sell their companies when they approach the end of their careers.

So, what does it look like from the buyer’s perspective? Read the rest of this entry »

Multiple Mania: Part 2 of 2

Previously, (Multiple Mania: Shortcutting Success) we had discussed earnings multiples and their value to the Mergers & Acquisitions process. As previously discussed, we tend to view earnings multiples as shortcuts which, when properly applied, can be useful as sanity checks, but we certainly would never recommend acquiring or selling a privately-held business strictly based upon an earnings or purchase price multiple.

Of course, there are many factors which influence multiples, as we discussed previously. One factor is the prevailing or current economic condition. We all know how bad the economy got in 2008 and 2009. We hope we are on the road to recovery, but there are still some rocks in our path.

Purchase price multiples are post-mortem account; you do not know the number until the transaction is closed. That is one of the problems with reviewing multiples. However, we do know during the period of 2006 to the middle of 2008, purchase price multiples were higher than they had been in the 2003 to 2005 timeframe. Those of us in the M&A business watched as purchase price multiples declined during the latter half of 2008 and the first nine months of 2009. Thankfully, we have seen a recovery in the market and a slight increase in multiples.

So what drives multiples? Read the rest of this entry »

The simple truth is that all business owners will exit their business. The timing will either be determined by you or for you. It is unfortunate, but statistics show thousands of businesses each year sell for a fraction of their market value because owners don’t understand the true value of the business. Others are transferred to family members only to fail soon thereafter. Many are sold at liquidation prices to satisfy estate taxes. Improper timing of the sale causes many entrepreneurs to receive less than maximum value. Worse yet, after a lifetime of work, the proceeds are not enough to sustain the owner’s retirement.

Many business owners are under the impression that because they have invested money and time into their venture, it is valuable and marketable. Nothing could be further from the truth. In fact, many owners have created perpetual full-time jobs, not sustainable, valuable and marketable enterprises. This problem exists in privately held companies of all sizes, from the small to the very large company. Contrary to the common belief, revenue size is not a formula for value.

Building business value is not necessarily the same thing as building bottom line. Let’s define value, recognizing that there are different kinds of value:

• Value for estate purposes – Takes into consideration the fact that the company will lose its driving force and have less capital to grow the business
• Value for stock ownership plans - Here we presume no change in running the company and no change in capital structure except, that which is necessary to service the new debt
• Value for mergers-and-acquisitions (M&A) – Here there will be new dedication, resources and an infusion of, or access to, the funds necessary for growing the business

To build value one must look at a business from an M&A perspective because value is the price which a willing and informed buyer will pay to a willing and informed seller with neither party being under duress.

Avoid the Common Myths of Value

Myth 1 – Value building is same as business building
It may come as a surprise but building the market value of the business is quite different than simply growing sales or profits. Certainly the more sales and profits a business has, the higher the value, but there are some hidden traps that will fool the naive owner. Higher sales or even greater profits may not always mean larger value!

Myth 2 – Value is constant
Market values of companies are dynamic, constantly changing, forever adjusting to the internal activities of the business and the external factors of the market.

Myth 3 – Value is obvious
There are no formulas, no rules of thumb, and no simple multiples that can determine with certainty what price an individual business will obtain in the marketplace. There can be general averages that apply across a broad number of companies in an industry, but such averages are usually inaccurate and often inappropriate for individual companies.

Therefore, value building must concentrate on what motivates sophisticated and serious buyers to pay premiums when they acquire businesses. In short, a practical strategy is one that is focused, specifically customized and stresses what works in the M&A marketplace. How the process works is not always obvious to owners who have difficulty seeing their companies from the perspective of a buyer.

posted by Susan Jones

In addition to teaching a “How to Value a Business” continuing education course each year, I am also asked to speak to various groups of CEOs, entrepreneurs and business owners on the same subject.  Regardless of the audience, invariably, someone will ask, “Jim, this valuation stuff is all well and good, but what is a simple multiple of earnings or formula to use to value a business?”

Face it, we all love shortcuts. We learn at an early age the benefits of shortcuts: whether we cut through our neighbor’s yard on our walk to school, clean our room by stuffing our messes into our closets, or even feed our unwanted vegetables to our dog (surreptitiously under the table, of course) so we can get the dessert our mothers’ promised if we clean our plates, who can resist a good shortcut?

Today, I still use the shortcuts my high school mathematics teacher taught us to check our addition and how to quickly multiply by 25. I doubt any of us can get through the day without utilizing at least one shortcut we learned as kids. For business buyers and sellers, multiples are simply shortcuts to the valuation and/or negotiation process.

When applied properly, multiples can be used effectively as sanity or temperature checks/gauges. However, I personally would not want to buy or sell a business based strictly upon a multiple. There are always so many variables to consider when acquiring or selling a business; basing such an important decision on a simple multiple does not make sense. Take a look at the following, admittedly simple, example as a way of illustrating my point. Read the rest of this entry »

Singing In the Rain

No doubt, for the past 18 months, the current economic crisis has hung over our heads like a summer storm over the Great Plains.  We are certain it will pass, but its rains and winds can produce lasting damage for all in its path.  In times such as these, we can either seek the comfort and security of shelter, or, more aggressively, we can learn to sing and dance in the rain.

Recently, I was invited to attend a recent summit of CEOs of mid-market companies.  I heard many CEOs who literally shouted: “Now is not the time to seek acquisitions because we do not know if we have hit bottom yet,” “Banks are not lending like they once did,” “How can we consider an acquisition now when we have our own business challenges?”  These were common themes and common statements during presentations, around the lunch table, and at the bar during cocktail hour.

However, a few of CEOs, those who I will call the “enlightened elite” embraced an alternative approach, exclaiming for all who would listen: “There has never been a better time than now to make acquisitions. Read the rest of this entry »

Another look at “Valuation: Getting the Right Price When Selling Your Business”, an article by Gary Parker.

I think Gary has done an excellent job of summarizing the valuation process. However, I feel that he and many others that have written about “valuing” your company have made the explanation too complicated or mysterious.

This writing is an attempt to simplify the explanation of this process and to provide a conclusion that hopefully gives potential clients more comfort that professional “intermediaries” like CFA can provide very reasonable estimates of what their company will be worth.

I am “certified” by NACVA (National Association of Certified Valuation Analysts), which required a great deal of study, testing and experience and as such, I feel I have learned to navigate the valuation “maze” more effectively.

The first and in many respects the most important question of a valuation is “what is its ‘purpose?’” While there can be many reasons for a valuation, the purpose for our clients is the sale of their company (all or part) and as such we will be using the Fair Market Value Approach. This is defined to mean “willing buyer, willing seller both acting with the same information and no compulsion to act”. While academic it is very practical when combined with the market experience of professionals like CFA that have seen hundreds of transactions during their careers. I will only say that other “purposes” such as estate planning will use different approaches, which lead to different methods mentioned in Gary’s article.

The second important point is Read the rest of this entry »

When selling all or part of a business, identifying qualified buyers is very important to an effective sales process.  Before I go into my process I would like to share a story that involves my joining CFA in 2004 and being interviewed by a senior investment banker from our Dallas office.

When I was explaining to him my “deal experience” from the four prior years he responded, “Oh, you have been working as a business broker”  I then asked him to explain to me how he distinguished between a business broker and an M&A advisor. He stated that if the “buy-side” was an individual as opposed to a professional buyer (i.e. a Private Equity Group or Corporate Acquisition Group) he would describe the transaction as business brokerage rather than M&A.

His point was that professional buyers are in the market everyday and need very little assistance in evaluating opportunities.  The individual buyer, no matter how sophisticated they think they are, is not in the market on an ongoing basis and therefore, will be less proficient and therefore a more risky prospect.

With that introduction, since joining CFA I no longer deal with individual buyers.  My concentration tends to focus on Read the rest of this entry »

A February 19th article in Private Equity Professional Digest titled The Resilient Middle Market Delivers Again: Deal Volume and Valuations Held Steady in Q4 points out that “middle market deal volume and valuations held steady from the third quarter to the fourth quarter of 2008, but the economic crisis severely impacted debt levels, which declined dramatically, according to GF Data Resources (GFDR), a proprietary database that collects data on private-equity transactions valued between $10 million and $250 million.”

In its Q4 report GFDR identified several trends regarding the current state of the market that lower middle-market business owners will want to take note of:

1. Average multiples on buyout transactions dropped from the mid-6.0x range in the first half of 2007, and have remained in the 5.8x – 6.0x range since.  Valuations have held up particularly well in the $50 million – $100 million TEV tier, where companies appear to benefit from being large enough to mitigate at least some of the risks relating to scale, but still small enough to get financing in the current credit market.
2. To measure the extent to which good companies have Read the rest of this entry »