Maximizing the Value of Business at the Time of Succession
How to help your clients do so and yet keep the sale affordable to their buyer.
October 3, 2011
How many of us have had clients eagerly share the story of a business owner friend who sold their company for a “premium” price? And how often have we heard a client report on the session they just attended in which a business broker or an investment banking organization got them very excited about selling their business for a windfall? What comes next, of course, is their request for your advice on how they can realize a big win through their own business succession.
Recognizing that entire books have been written on this topic, your initial recommendations might include:
How Sellers Can Impact Business Value
There are three primary methods that business appraisers use to assess the value of the companies they appraise:
Each of these methods arrives at an independent conclusion and has more or less potential to be impacted by the seller. For example, you and your client have very little direct influence on the value conclusions resulting from the market approach (what others buyers are paying for similar businesses in the open market). However, you can influence the appraised value yielded by this method indirectly, by coaching your client on how to enhance sales volume or operating margins. These numbers are multiplied by factors derived from sales-transaction databases created with data submitted by business brokers.
Similarly, the asset approach offers little opportunity to impact the appraised value. This method converts the historical book value of assets to market values, thereby arriving at a total value of assets based on what is being paid in the open market for like assets. Hopefully your client has assets, both on and off their balance sheet, that are highly valued by prospective buyers and in good condition. “Good condition” can mean collectible in the case of receivables, convertible into cash in the case of inventory or in high demand and readily saleable with regard to real estate and other assets including intellectual property.
The income approach gives your client the greatest ability to influence the value of their business. It is also the valuation approach that appraisers use the most extensively in negotiating actual sales of businesses. Fundamental to this approach is business income or cash-flow. Anything your clients can do to positively influence these elements will clearly enhance value (as long as the positive changes are sustainable). In other words, creating a lean, mean operating structure and cranking up sales growth substantially should be the goal in the years leading up to a sale. Hitting the top of the growth curve on release of a new product or service would also create an “ideal” opportunity to position a sale.
Having “best ever” earnings/cash-flow and a high-growth rate to plug into the valuation model will maximize the value conclusions for your client’s business. Having depth of management, a healthy balance sheet and other favorable tangible and intangible factors specific to your client’s business will also minimize the level of company-specific risk that is part of every multiple/capitalization rate used within the income approach.
In the overall scheme of things, help your client get their business to a level of peak performance with even more outstanding prospects for the future maximizes value, where that value is further enhanced by an excellent pool of assets (tangible, intangible and leadership). In addition to completing a business valuation, it is also essential to assist your client with forecasting or recasting financial data to show “true earnings.”
Keeping a Business Affordable
The next step is to find a pool of buyers who are interested and can both afford and access financing for the deal … a more challenging proposition than ever in our current economy. Having the price be affordable is particularly relevant where ownership transitions will occur between family members or to key employees who may not have significant personal resources to invest in the business. In any case, a lower price will expand the pool of buyers. Ways you can help your client effectively reduce the asking price include:
Any of these measures needs to be evaluated to assess the after-tax benefit to the owners versus merely negotiating a higher selling price. They also need to be appropriately weighed against the personal financial goals of the seller and the working capital needs of the business. Selling a sequence of minority-interest pieces is yet another way to transition at a favorable price by using a minority discount. This strategy can sometimes reduce the price significantly.
With the topic of affordability in mind, in an upcoming article, I will reveal whether or not your clients should have their children “pay for” their ownership interest in a family-owned business.