As a business owner, you may have one or more choices when it comes to exiting your business. You’ll either pass it on to a family member, sell it to a third party or shut it down. Generally, your business will have a different value in each of these situations. Isn’t it a good idea to know how much your business is worth now so you can decide which choice is best for you when the time comes?
Recently, I spoke with a business owner with a 20-plus year track record who is considering a sale of his business. In his opinion, he has two options. One option involves selling to a family member. The other possibility is to sell to a larger company. I explained that one choice might bring a higher value. And the important thing to know, is which one.
There are several types of buyers :
• Financial buyers – motivated by income, usually individuals. They focus on companies with revenues under $10,000,000. These make up the bulk of business sale transactions.
• Strategic buyers – generally larger companies, seeking companies with revenues over $10,000,000. These buyers are looking for companies who provide differentiation, proprietary products/services, and are financially solid.
• Family, partner, employee buyers – requires 3 to 5 years of advanced planning to execute successfully. Exit planning includes tax, estate, and business continuation preparation to provide a well-timed and effective sale.
• Industry Buyer or “buyer of last resort” -These buyers look for companies that have poor financial performance, including low or no profit, partnership problems, death, divorce or illness of owner, or other problem situation. This buyer will pay the least and the seller generally gets the liquidation value of tangible assets.
In this business owner’s situation, the larger company wanted to review the business financials to determine if they would proceed with an offer. Now while this makes logical sense, it is not a good idea just to hand your financials over to a potential buyer, even if they are family members without preparation. Let me explain.
Sending your financials and tax returns to a buyer without knowing the value of your business puts you in a very weak negotiating position. Why? Because you won’t know if the offer they make, if they do make one, is a fair offer for your business.
Second, you are assuming the buyer understands your business, the industry, your challenges, opportunities, successes, and customer base. Third, its not likely that a buyer knows how to appropriately interpret your financial statements to give you the best price. Presenting your business to encourage interest from a buyer requires preparation, analysis and professional guidance.
Finally, if you send your financials to a buyer without first receiving a properly executed Non-Disclosure Agreement, you run the risk of having your competitors, customers, vendors, neighbors, employees, etc. know the financial status of your business. This could hurt the value of your business if you lose customers and employees due to your private business information becoming public.
A sale to family members may be even more challenging than selling to a third party. Every business sale has emotional elements for the seller and buyer but with family businesses, understanding how to transition it to the next generation successfully can take years of planning and execution.
If you are like most small business owners, you receive certain benefits called perquisites (or “perks”) from your business. Company profit and certain expenses such as your salary, depreciation, interest, health and life insurance and other one-time, non-recurring expenses may be used to calculate Seller’s Discretionary Earnings or SDE. This is the number a buyer wants to know but in many cases doesn’t know how to adequately explain it to you.
A buyer is interested in the cash flow your business will generate in the future. A buyer wants to know that this cash flow is repeatable and sustainable. And that the company can finance the acquisition and pay the buyer an adequate return on investment as well as a living wage.
An experienced business intermediary or valuation expert will analyze the last 3 to 5 years of your business financials and tax returns to ferret out the true owner’s financial benefit. This owner benefit figure called Seller’s Discretionary Earnings or SDE is applied to a number called a “multiple”.
This multiple is determined by doing research and data analysis of sold companies in the same industry. Calculating and defending a multiple of earnings for your business requires knowledge, and experience. This is just one part of preparing a price or value estimate for your company.
Experts will tell you that business valuation is an “art and a science”. There is not one definitive valuation number for your business. Value depends upon the buyer type, your company’s financial performance, economic status, your industry, your company’s differentiation, your customer base, your tax and pre-exit planning and more.
You can increase the value of your company before selling but like any journey you need a compass and a roadmap. What is your starting point? Where do you want to go? Who will help you get there? As modern philosopher George Harrison said, “If you don’t know where you’re going, any road will take you there.”