Commentary by Jeff Cornwall
http://www.tennessean.com/apps/pbcs.dll/article?AID=2009905110317
There appears to be an increase in the number of entrepreneurs selling their businesses over the past few months. Financially strong companies and cash-rich investors looking for good acquisitions are starting to move into the market.
Just having assets such as buildings, land, equipment and even inventory is not what creates value. Those assets must have the ability to continue to earn profits for a new owner. It is the prospect of those future profits that gives a business its real value.
The simplest way to think about business value is this: People are buying your business’s ability to generate future profits. Typically, the value is based on a multiple of profits. Historically, valuations have been about three to eight times annual operating cash profits (ignoring things like depreciation, corporate taxes and interest expenses) with the most typical multiplier being about four.
If a buyer offers a multiple of profits of four, and your business has operating cash profits of $100,000, you can expect a valuation of about $400,000.
Since it is a buyer’s market right now, you need to set realistic expectations going into any discussions about a sale of your business. I am hearing that there has been about a one-point drop to a multiple of three times profits.
What does that mean? Just like home values, your business’s value has dropped by about 25 percent, all things being equal.
But remember: The other part of the valuation equation is the profitability of the business.
How to prepare
Most entrepreneurs have reported a significant drop in their profit margins over the past year. So, that means that the drop in values could become much greater than 20 percent or 25 percent if profits are also down. My advice is as follows:
Understand what drives the value of a business. What multiple you are likely to get is based on your projected growth, the health of your industry, the strength of your customer base projected into the future, and specific strategic advantages that you may be able to offer the buyer.
Know your number. If you need a certain amount of money from your business to retire, have that number in mind going in. If the market is not supporting that value right now, you might want to wait until a later time. Use that time to improve your profitability so that when the economy picks up your operation will have an even greater value.
Seek expert advice. Work with your certified public accountant and an attorney who specializes in mergers and acquisitions to understand the process and to help set realistic expectations. This will be money well spent.
Realize that deals change. Once the buyer gets into due diligence, the price may drop. Once they learn more about the business, they may lower their projections for what they believe your business can earn for them in the future.
Be prepared for this, and know how much you are willing to go down ahead of time. Be ready to walk away if the price they are willing to pay drops too much.
Don’t let your emotions lead you to take an overly discounted price — buyers can smell desperation and will use that to their advantage by trying to drive down the price during due diligence.
The odds are that about one out of 50 inquiries about buying a business will lead to an actual sale. Keep a level head and don’t even dream about how you’ll spend all of that money until you get it in the bank.
