What's it Worth? That Depends...
Grooming May Make a Difference
By Gary Roelke , Principal
New York Metro Region Office, Corporate Finance Associates
What is your company worth? That is a function of many factors, including historic and future financial performance, industry risks, market timing, method of sale and the nature of the
Value becomes an absolute only at the very instant a knowledgeable buyer under no compulsion to purchase,
authorizes the wire transfer of funds to the bank account of a knowledgeable seller under no compulsion to sell. Otherwise, different people with different needs, resources and
limitations will perceive value of the same asset in differing ways. As the business owner, you can use this knowledge to your benefit by specifically grooming the business to fit the
probable requirements of the eventual new owners.
A recently published graduate school text on private capital market theory1 postulates that, in the transfer of business ownership it is owner motives that that determine
both the “transfer channel” and “transfer method.” These, in turn, broadly dictate both value boundaries and deal structure.
The author segments capital markets by size into a continuum from small to large. In a related, but separate notion, he demonstrates a value spectrum that runs in seven clusters
(“transfer channels”) from lowest multiples (sale to insiders) to the highest (sale to outsiders). Without any further facts, we can postulate that low values are assigned to small
companies selling to insiders, while large companies selling to public companies receive much higher valuations. You might want to take a closer look at three of his transfer channels:
employees, outsiders (and retire), and recapitalize.
Sell to Employees:
Sales to employees usually are at “market value” (asset-driven); deal structure includes such alphabet soup as ESOPs, MBOs, MBIs, Options, Phantom Securities, and SARs. Because (i)
employees tend not to have accumulated personal wealth, and (ii) owner sentiment (guilt, loyalty, etc.) often is brought into the process, these deals tend to include a substantial
portion of seller notes.
So, if it is your desire to sell the business to your employees, then you should groom several of them to be senior managers; extract as much wealth from the company as possible before
hand; get the pre-sale balance sheet into good shape by paying down debt and eliminating your owner-specific items.
Sell to an Outsider and retire:
Sales to outsiders typically are negotiated based on “fair market values” (scale, profit, strategy and synergy driven) determined by either a one-step private auction, or a two-step
public auction (don’t wince—“auction” is an investment banking term for a stylized selling process in which several buyers are induced to kick-off the process by making an offer). Deal
structure usually includes staggered performance payments to ensure a smooth management transition and full transfer of customer and vendor loyalties.
There are many value drivers that will appeal to outsiders, but strong management, robust internal and financial controls and reporting, and solid vendor and customer relationships all
play a part. Audited financial statements are a plus, but not obligatory. Proprietary products or other barriers to entry are a big boost to value, as is the absence of customer
concentration. Curiously, “curb appeal” and good housekeeping are also very important in making a solid first impression, as most corporate-trained buyers regard this as a quick
indicator of sound management practice.
Sell to Outsiders, But Continue to Drive Growth:
These deals often are called consolidations, roll-ups, buy and build, and recaps. They can be used to facilitate an inter-generational transfer of ownership, particularly if the next
generation already is integral to the successful operation of the business, but prefers to minimize personal risk by using outside funding to buy out the older generation’s interests.
The next generation can harvest some liquidity and retain a substantial equity stake in the future business.
Everything that applied to the prior transfer channel also applies here, plus the added requirement that the business be big enough to attract the attention of the deal sponsors who
specialize in this type of value creation. Above all, leadership and reliable control and reporting structures are paramount, if yours is to be the first business they buy in a sector
(the so-called “platform”). Rapid, profitable growth and near-term balance sheet recovery are mandatory. Why? Because the end game is usually a sale of a much larger entity at much
higher valuation multiples, either to a strategic buyer, or through an initial public offering, yet the time horizon is a short three-to-five years. It is typical for the continuing
owners to realize even more money on this “second bite of the apple” than they did on the first.
Select the Best Advisors:
The dealing process is time consuming, inordinately complex and highly risk-laden. You are likely to have most of your net worth at risk in the process, so this is one of those moments
where you should insist on working with the very best people to whom you have access.
Your advisory team should include an accountant, lawyer, tax specialist and transaction specialist; circumstances may dictate others, such as an environmental engineer. Be very direct
with your traditional accountant and lawyer and ask each of them how many successful M&A deals they personally participated in over the past 12 months. You may find that they’ll
suggest retaining “special counsel” to assist them (that is a good thing, by the way). Finally, your chosen transaction advisor should be an M&A firm with deep resources and a great
deal of relevant experience.
Value is driven by process, perception and facts. Determine now what you want to accomplish with your eventual exit (charity, gifting to family, sale to employees, maximize value,
etc.) That, in turn, will point you to a category of buyers (insiders vs. outsiders), value and deal structuring expectations. Those buyers’ probable requirements will suggest how best
to groom your company for sale. Your preparedness for sale and prevailing market conditions will dictate when you should undertake the process. The right deal team will make your sale
1Slee, Robert T.; Private Capital Markets: valuation, capitalization,
and transfer of private business interests; John
Wiley & Sons, Inc.; Hoboken, NJ; 2004.
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