Improving the Perceived Value of a Business
Many business owners are hesitant to sell their business – what is probably their largest asset – unless a sexy opportunity comes along; for some that opportunity may simply be to get out of the business, and for others it may be to transition to another one. Whatever the case may be, there is a natural conflict of interest between the seller and the buyer regarding price. Nevertheless, one key to selling at a good price is the ability to produce and defend a valuation of the business.
There are many things to be considered when performing a valuation of a business. Often, M&A advisors and investment bankers will use several methods (Discounted Cash Flow analysis, Precedent Transaction analysis, and several other comparable metrics), the combination of which helps to provide a plausible range in which the business could be sold. Note: if you hire a team of advisors, then their valuations alone will not produce a selling price; there are many negotiations involved between buyer and seller, and generally speaking the selling price can be very flexible. However, whatever the valuation methods may be, they help to defend a quoted price and they are also based on important assumptions.
Assumptions are essential in the valuation process. Economists are often criticized for the assumptions they use, but ultimately they help to simplify complexities into variables that can be understood and predicted, ceteris paribus. When it comes to making assumptions to valuate a business, it’s important to understand their limitations; i.e., what can a valuation method say and what can’t it say? Projecting sales growth can be increasingly difficult when past sales have been volatile, for instance, and the smallest change in assumed interest rates can be the difference between a profitable investment and a huge loss. For this reason, a variety of valuation methods are used.
What a seller needs to understand, however, is that they have much control over some assumptions that will be used to value their business. A few examples include:
- Good management – Having a solid management team is highly valued by buyers who want a smooth transition into the future of the business. Even the seller offering to serve as a consultant for the first several months after closing the sale can raise the selling price. Such security significantly reduces the anticipated risk assumed by the buyer.
- Revenue trends – This is why it’s important to choose when to sell the business. It’s favorable to sell when revenues are growing, not declining. If revenues have plateaued or declined, then a great opportunity has been lost to capture an attractive projection of the business’ future cash flows. Remember, it’s hard to sell a business on favorable revenue trends alone, but it’s even harder to oversell past performance.
- Anticipated expenditures – Is the business ready to sell? If the buyer has to assume costly improvements in order to maintain the business’ competitive advantage, then the valuation will likewise be reduced. This can apply to necessary technology improvements or the replacement of depreciated assets. Some expenses are necessary for the operation of the business, but a “tune-up” can do much to reduce the perceived need of costly improvements.
- Tax write-offs – This example especially applies to many smaller family-owned businesses. Often, owners will hold allowance accounts for just about anything, mixing business expenses with personal expenses, and then use them as tax write-offs. Although this helps to reduce tax expenses, the problem with this practice is that it makes the business appear to be less profitable than it really is, thus lowering the perceived value.
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