Business Owners FAQ, Part 3: True Market Value

Travis Watters Business Owners FAQ

Over the years we have had a variety of questions posed by business owners. We thought it would be a good idea to put some of the most common questions in one place for easy access. This blog series is a compilation of those common questions. This five part blog should provide a good starting point for most business owners.

Below is Part 3 to the Business Owners FAQ. The following are the other segments of the FAQ in the suggested order of reading:

  1. Part 1 – When Should I Sell My Business
  2. Part 2 – Potential Buyers
  3. Part 3 – True Market Value
  4. Part 4 – The Acquisition Offer
  5. Part 5 – Common Mistake and Conclusion


 

How do I know what my business is really worth?

The true market value of a business to the strategic buyer is not quantifiable by a valuation formula and can be very difficult to determine, even by examining comparable transactions. An Investment Banking firm can provide you with a valuation that reflects your company’s value based upon the current industry and market conditions.

Real value, or true market value, is market-driven. It can be widely different from what a classic midlevel valuation would predict. Accordingly, it is unusual for a financial valuation to give an accurate picture of saleable market value. Savvy buyers are buying the anticipated future earning stream of the company.

Nonetheless, business owners often want a rule of thumb to hang their hats on. Generally, buyers will talk about pricing rules of thumb, either as a multiple of annual earnings or as a percentage of annual sales. The amounts vary greatly depending on the niche. For example, an “average” fabricator with stable and decent profitability might expect to achieve a selling price of 5-7 times pretax earnings. In an aggressive industry segment, where acquisition activity is high, such pricing might climb to 8-10 times earnings, as the norm. In a segment that appears to be strained, or where the future looks grim, such multiples could drop to 3-4. Also, in some segments, bottom line earnings are far less important. The gross sales volume may be the driving force in rules of thumb, instead. We are, for example, currently working with a specialty process piping fabricator (a very strong niche today), which we expect to bring about 125% of sales. In this case, such pricing will produce a huge multiple on earnings.

Please don’t allow a buyer to influence your value of your company by formulas/ratios from previous sales. This is a technique used by buyers to minimize the price they pay. Remember formulas are an expression of value and not a determinate of value. All formulas are based on historical data and premium buyers are buying future earnings. You must create an optimistic future (pro forma) made believable by good market research.

As you try to analyze your own industry rules of thumb, keep in mind, various buyers may not consistently apply them. Some buyers talk of multiples of net earnings, after tax. Others talk of pretax earnings before interest and tax (EBIT), or even earnings before interest, taxes and depreciation allowance (EBITDA).

Some buyers will buy only assets at their rule of thumb price, which leaves the seller to pay off any liabilities. Others will accept trade payables but no debt. Still others will pay such rule of thumb price for net stock. Also, keep in mind that when two or more aggressive buyers are contending, all rules of thumb are meaningless. With strong competition, market drive takes over — usually to the seller’s great advantage. This justifies the statement, “One buyer is no buyer”.

How can I find the best buyers to maximize my true market value?

Almost all sellers think they know which handful of companies will pay the most for their business. These initial assessments are wrong 80% of the time. The best buyers are seldom the most obvious. A statement attributed to one of our principals says, “The buyer seldom buys what the seller thinks he is selling”.

Identifying buyers to achieve maximum true market value pricing is a significant project. However, it is probably worth between 50 and 100 percent more in pricing. Therefore, it is worth the time, effort, and cost.

Buyers should be considered from every possible angle. In many instances, the best buyers do not come from horizontal companies (those in the same business as the seller), or vertical companies (suppliers or customers).

Buyers come from all types of companies who want access to your customers. They come from unrelated companies with a budding desire to add processes or technologies. They include foreign buyers, conglomerates, emerging roll-ups, venture capital firms, and joint venture combinations. The possible fits are countless.

Without careful study of the prospective buyer markets, owners invariably leave significant amounts of money on the table. It can be well worth the cost and time to hire professionals to thoroughly analyze markets.

A seller should be prepared by remaining alert to similar transactions that are taking place. Read trade publications, newspapers, and periodicals. Monitor activity you hear about through trade associations and conferences, and generally keep in touch with other business owners in your segment. Maintain a file of clippings and notes about info you gather, and watch for trends as new contenders enter your industry. Also, unsolicited calls can be used to the seller’s advantage if pricing norms or guidelines used by the various potential buyers can be ascertained.

Before approaching buyers with details on your own company, the more information you can obtain about who’s buying, what they’re paying, and who specifically is currently aggressive in the marketplace, the better. Sophisticated targeting of buyers in advance greatly enhances both privacy, and the likelihood for achieving maximum pricing in sale.

How much should I ask for as a selling price?

Even after getting good information on perceived values, it is still imprudent to set pricing for buyers. The most successful path to maximizing pricing is the “limited auction”. In this process prospective buyers set their own price. In spite of buyer protests, the seller simply refuses to give the buyer an asking price.

A limited auction can be hard to do. Potential buyers do not like starting from scratch, and the average businessperson may feel badly for making them do so. However, it pays to be tough, even if someone has to be hired to do it. The buyer should be made aware that there will be competition, and that the price should be set as aggressively as the buyers see fit.




Continue reading onto Part 4 to learn more about how to handle and evaluate acquisition offers, or skip to Part 5 (The Most Common Mistake and Conclusions). You can also go back to Part 1 (When Should I Sell My Business?) or Part 2 (Potential Buyers). Please feel free to contact us directly if you have any questions or if you are interested in exploring a possible sale of your business. You can also learn more by requested one of our publications. In particular, our book “The Practical Guide to Selling Your Business” and the article “Uni’s 12 Value Drivers to Increase Corporate Valuations” are very valuable to business owners interested in learning more about selling their business. We hope to hear from you soon.

Travis WattersBusiness Owners FAQ, Part 3: True Market Value