Back to Basics
Be a Trusted Advisor
Valuation analysts are in a unique position to help their clients. Most business owners have never looked at their business the way a valuation professional does. If the valuation analyst does a yearly check-up or checks in with their clients but does not include a discussion or a strategy to build value in their business, perhaps it should. This is an opportunity to expand the work base with existing clients and establish good or better relationships. Coming into this year-end, now may be the perfect time to discuss the steps to take today.
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Every year, business owners set new goals to retain customers, expand products or services, and build their client base. But how often do owners of private companies sit down to devise a plan to build value in their company? The need for building value is in the present, not in the future when a partner is ready to move on, or a sole owner is ready to sell or transition the business to a new owner. Developing a strategic and tactical plan to build value in the business can help owners plan for their eventual exit.
Back to Basics
Business values at their root are a function of the cash flow one would expect to receive in the future (including growth) from an investment in the business, the time frame for the investor to remain an owner of the business, and the return of and on the investment. This return includes the investorâ€™s (ownerâ€™s) perspective on the relative risk of achieving their goals. Simply stated: value is a function of cash flow, growth, and risk.
This statement represents how businesses are run (or perhaps should be run) and, for better or worse, one component of value cannot â€śmoveâ€ť without the other components being affected.
We know that business valuation is an intellectual exercise and not a one-dimensional formula with â€śinputs.â€ť It is the result of the dynamic interaction of key components that are inseparable; namely cash flow, growth, and expected returns on and of capital invested.
Communication between the business owner(s) and their advisory team is the foundation for a successful â€śValue Buildâ€ť and exit plan. Developing clear goals and objectives is one of the first steps. And a business valuation is many times the rallying point for a successful exit plan, no matter what the time horizon.
Consider two competitors in the manufacturing industry (ABC Co. and XYZ Co.); they are similar in size and their recent financial performance shows one million dollars of earnings before interest, taxes, depreciation and amortization (EBITDA). ABC Co.â€™s advisor stated the general rule of thumb used for such manufacturing companies is five times EBITDA, meaning the company, in his eyes, was worth five million dollars.
Letâ€™s look a bit deeper: XYZ Co.â€™s client list was well-diversified (ABCâ€™s was not); XYZ Co. had a succession plan; (ABC Co. did not); XYZ had a proactive approach to business development (ABC Co. was dependent on the owner). Using the multiple of five, both companies would be valued identically…but which company would you be willing to pay more for? Which has more value?
These so-called rules of thumb or multiples based on some financial measurements are not useful tools to determine the current worth of an operating business. Sure, they are simple to use and, on the surface, easy to explain; however, they are, at best, an incomplete way to gain insight into the value of a business. Isolated financial ratios represent perhaps only a glimpse into a companyâ€™s value. This approach ignores business and other related information that could influence the companyâ€™s value such as: relative performance, growth prospects, management, customer lists, capital requirements, and competitive advantages to name a few. In addition, such general approaches to business valuation fail to consider two of the most important questions: â€śWho wants to know what the business is worth?â€ť and â€śWhy do they need to know?â€ť
A more complete valuation will consider all approaches and may use multiple approaches. It will purposely include the owner and management teamâ€™s knowledge to consider all the unique factors relevant to the specific business being valued. A business valuation is a unique combination of art and science and should not be reduced to the use of a calculator and a table of figures.
The Small Business Market
The past 10 years were supposed to be the great â€śheydayâ€ť for the small business owners as they look to retire and exit their business for high prices. We all know the recession dampened that enthusiasm somewhat; however, the discussions are ramping up again…at least according to my e-mail inbox. I am on the receiving end of many marketing-oriented opportunities to supply businesses for sale to willing buyers (both individual and groups) as well as many organizations looking to help me become more successful in my practice. The idea that a large wave of businesses for sale would fuel downward pressure on prices does not appear to have materialized. Pitchbook (a private capital markets research firm) tracks deals in the lower middle market (defined as deals in the $10 million to $100 million range). Since the financial crisis, sellers have increased and overall valuations have increased according to Pitchbook. BizBuySell.com (an online marketplace for small business sale listings) also report that selling prices have increased in 2015. So it does not seem like the negative impact on values expected with the increased number of businesses for sale has taken hold. Perhaps the businesses sold have been the better-quality businesses; i.e., they had good business economics supporting the value and ultimate pricing received in a transaction. And the unsold businesses were just not that good in the eyes of the pool of buyers. The increase in prices in the small business and lower middle market may be the result of selection biasâ€”that is, the good ones sell, and the bad ones do not. Pretty simple, huh? However, what is not entirely clear is how have the terms of the sale changed over time. Terms of a sale are perhaps the most critical component in understanding the true nature of the price being paid. Recall the old buyer axiomâ€”â€śYou can name the price; Iâ€™ll name the terms.â€ť Gives the seller bragging rightsâ€”but not much more.
In the end, echoing sentiments of my private equity fund and investor friends, a business with good economic fundamentals will always be in demandâ€”it only takes one buyer, the â€śrightâ€ť buyer. I have seen many a deal done go bad because the proper due diligence was not carried out by the seller. The focus for business owners should be on building value by improving their fundamentalsâ€”whether they are positioning the business for sale or not. In fact, there are also situations where it just may be worth more to the owner to remain an owner and build the value versus selling and letting others reap the rewards from the foundation they have established.
So, what is a valuation professional supposed to do?
You are in a unique position to help your clients. Most business owners have never looked at their business the way a valuation professional does. If your yearly check-up or check in with your clients do not include a discussion or a strategy to build value in their business, perhaps it should. This is an opportunity to expand your work with existing clients and good relationshipsâ€”making them even stronger. Coming into this year-end now may be the perfect time to discuss the steps you can take today, to help build value for tomorrow in your clientsâ€™ businesses as well as your own. What are you waiting for?
 https://ibgbusiness.com/wheres-the-business-selling-tsunami/ – data reported through 2015; accessed October 29, 2018.
Steven M. Egna, ASA, CBA, CVA, ABAR, CM&AA, is Senior Advisor at Valuation Resource Group, LLC, an East Greenbush, New York valuation, litigation support, transition planning, and M&A Advisory Services firm. Mr. Egna has over 30 years of diversified financial leadership and management experience specializing in transition planning and valuation analysis of all sorts. He brings a practical, hands on approach to all of his work.
Mr. Egna can be contacted at firstname.lastname@example.org or at (518) 479-1008.