After reading "Selling Your Business Part I - Making the Decision to Sell or Keep", you may be here because you decided selling your business may be something you’re actually interested in doing and you want an idea as to where you should start.
Valuing your company and finding buyers may seem like taxing work, which is why we have covered a few ways to help you get the process started.
How to Find Buyers
Just as there are many ways to skin a cat, there are also many ways to find buyers. We are going to address three main avenues to search for buyers: personal connections, business brokers, and investment bankers.
The first rule of thumb: the more your business is worth and the higher amount of work it takes to value and sell your business, the more help you will need in finding appropriate buyers.
If you are selling a business with revenues of less than $1 million, you may need minimal assistance finding a buyer. Our first suggestion is to minimize your costs.
Work your current personal connections. Ask yourself, who would know potential buyers? Who are your suppliers, vendors, competitors, trade association members, and industry connections? Spread the word among friends and these contacts. The most unlikely source may have a great lead. These will often be the contacts who can lead you to a qualified buyer from a source you trust.
Although you may find a buyer on your own and negotiate the deal on your own, we still strongly suggest you use your team to help evaluate the deal.
However, let’s say that you don’t want to take the time to find a buyer and your business revenue is below $3 million. Perhaps this is your first and only time negotiating a deal. In this case, we encourage clients to find a quality business broker.
Ideally, find a specialist in your area who deals regularly in your industry rather than a generalist. This way the broker will be familiar with the issues in your industry. They will be able to give guidance on the pitfalls and landmines that may blow up your deal.
The business broker will typically focus on advertising your business online and may put together some marketing kits for interested buyers. They will help negotiate the deal as well as market your firm. Fees range greatly, but usually the larger the deal, the lower the commission – ranging from 3 percent to 10 percent depending upon the level of service. Please keep in mind that fees are always negotiable. However, many have learned that you often get what you pay for.
If there are business brokers, what’s the need for an investment banker? In the book Keep or Sell Your Business by Mike Cohn, he states that investment bankers are usually needed more often for the larger deals above $3 million. They will have better strategic relationships among those companies with capital to employ. They often help structure the leverage (debt) and equity for the deals and are more experienced negotiating and navigating the complexities of publicly traded companies.
Investment bankers will also have relationships with other specialists who will add value to the deal, i.e. business appraisers and auditors who can help you sort through the buyers as well as how to present your business in the best light. Investment bankers are not cheap. They will usually require a flat retainer fee as well a percentage commission once the deal is closed.
How to Value Your Company
Now that you know the kind of buyer you are looking for and have found an avenue suitable to find that buyer, the next step is to value the company and put a price tag on it.
There are some basic rules of the road related to each industry – you and your team should get intimately familiar with these rules and how other companies are valued within your industry. Some industries focus on a revenue multiple. Other industries focus on an earnings multiple or cash flow multiple. All of these multiples are affected by the quality of the assets and cash flows. How much revenue is recurring versus non-recurring? What marketing systems or patents do you have in place that is unique that can differentiate your firm? We will get into examples of each of these.
Above all, please keep in mind that buyers are not looking for purely historical performance. They want to know what future revenues are going to be. This is the motivation for making sure you are putting down solid numbers based on reasonable assumptions. This involves making sure the members of your team are involved in putting together and auditing and cross-checking the various numbers that will be presented.
First, explore your expenses and balance sheet and ask yourself, “What do I have or what are regular expenses that are truly just personal decision making?” This is vital because there may be additional ways to add value to your business.
For example, let’s say you have a business with 15 employees. Twelve of the employees are full-time workers and add significant value to your practice. One of the employees on the payroll is your spouse who does some odd jobs here and there, but overall is getting paid like a full-time employee and is just on the payroll to help contribute to your retirement accounts (i.e., 401k or SIMPLE IRA) and to save money on taxes. By pointing out to the prospective buyer that these are ways to immediately increase profits and cut payroll, this will drive down costs and increase the value of your business
Also, you may regularly buy pieces of art that you hold in the office. However, they are expensed as part of the office. By pointing out some owner specific expenses that truly are not vital to running the business and are hobbies, you can also add back to income and increase the value of your business. A business broker as well as your CPA should become intimately familiar with your business to help point out these sorts of numbers.
Now that you have adjusted your numbers to reflect fundamental changes to add value, let’s address the various multiples we discussed earlier.
Below is an example of a very simple income/cash flow statement and then we’ll get into how you could value a company:
As a simple rule of thumb, take an average of the last year and the next 2 projected years of EBIT, cash flow, and revenue.
So for example, the average revenue of the period is:
(10,000,000+10,500,000+11,550,000)/3 = $32,050,000/3 = $10,683,000. A common multiple of revenue is 1 times the gross revenue or $10,683,000. This is usually the most aggressive of our assumptions.
Most companies value businesses based on 4 times to 8 times EBIT or 4 times to 6 times cash flow. Below is a table of valuations based on each of these methods. Some industries are particularly strongly oriented to a particular method. For example, commercial real estate companies focus on funds from operations (FFO) which adds back depreciation to net income but does not include new capital investments into properties or accounts receivable or accounts payable. Other industries focus on revenue multiples and others focus on earnings. Get to know what is acceptable in your industry and see what you can do to have high quality numbers relative to other sellers.
Keep in mind that your business value may differ wildly from our assumptions for each of these methods because of the values we have plugged in for revenue, COGS, selling expenses, and all of the other variables.
There are many other complicated methods to calculate business value including discounted free cash flow models and the Gordon Growth dividend discount model, calculating comparable P/E and P/S ratios, using book value, estimated enterprise value, and many more models. There are also many good books on the subject that we could not fit for the purposes of this blog series.
Please keep in mind that once you do value your business that the numbers are only good for a limited amount of time – say 90 to 120 days.
In part 3 of our series, we will show you how to compare and contrast different types of buyers. We’ll discuss the five basic types of buyers: consolidators, investors, new entrants, horizontal and vertical acquirers, and in-firm buyouts.
What are some things you found helpful so far in this series? Let me know at email@example.com!
Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Individual needs vary & require consideration of your unique objectives & financial situation. Please consult with your accountant or tax advisor for specific guidance.