For the last 35+ years, I have been meeting with entrepreneurs to discuss exit planning, positioning their business for sale, and taking the business to market. After discussing goals and objectives, we discuss the process of going to market, timing, and collecting appropriate information relating to the value of the business.
The first question I am typically asked is, “What is the number?” or, more specifically, “What is my business worth?” It is also not uncommon to get that question over the phone with an introductory comment along the lines of, “I have a distribution business that has been in business for XX years and the business grossed $Y,YYY,YYY last year.” Although I wish that I was smart enough to respond with a reasonably accurate answer, in reality, the process to reach an opinion of market value is fairly complex and involves many factors.
Before discussing some of those factors, it is important to differentiate an opinion of market value from an appraisal. An appraisal is a more formal valuation used for a specific purpose, such as estate or gift tax value, determining the value of a marital estate for a divorce, or the value of a business for the buyback of stock for buy/sell agreements. The appraised value of the same business can be different in each of these scenarios, as there are regulations that provide guidance for tax purposes, state law court opinions for divorces, and, sometimes, formulas built into the buy/sell agreement.
How to Calculate a Fair Opinion of Market Value
For our purposes, we will calculate an opinion of market value based on a number of factors, including the following:
Fair Market Value of Assets
This can include tangible assets, such as furniture, fixtures, equipment, and inventory, as well as intangible assets, such as patents, trademarks, and tradenames. It is important to note that the appropriate number to use for each asset is not the book value of the asset or the new replacement cost of the asset, but rather what it would cost to buy a similar asset of that age and condition.
This metric is often measured by EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) for larger businesses that use GAAP accounting, or SDE (Seller’s Discretionary Earnings) for smaller, privately owned businesses that use less disciplined accounting and where the business owner may expense items, such as personal vehicles, excessively-compensated family members, and write off of club memberships. Regardless of the metric used, cash flow is typically one of the primary drivers of value.
This factor applies to both the industry and the individual business. Are sales and profits increasing, decreasing, or remaining flat? Are margins consistent? Is the industry segment growing or declining?
We are currently in one of the best M&A markets in history. Buyer demand is high, money is relatively cheap and available, and there are more buyers than good businesses available to purchase. The Colorado market is particularly attractive due to its growing economy, central location, and high quality of life.
We are advising potential sell-side clients that, if they are contemplating the sale of their business within the next three years, they should strongly consider going to market now. If you fall within that category, we can help to determine “What is the number?”
The majority of our business is derived from referrals. Please consider referring our services if you encounter a situation involving the potential purchase or sale of a business.
Ronald V. Chernak
Inspiring business relationships since 1982!
(originally posted in the November 2017 newsletter)