Value Drivers

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Hopefully you’ve read the recent posts regarding the value of businesses and the impact the owner’s actions have on business value. If not, you can review the posts here on the Apex Blog. If you have clients and/or friends who are business owners, please pass along to them.

I recently read a great article with some similar information from a trusted journalistic source, The Wall Street Journal, that confirms what we have been saying.

Enjoy the read and have a great holiday weekend.

Value Drivers: Revenue Trends

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upwardtrendBuy Low – Sell High: This practice makes sense with investments and it makes sense when thinking of your business value. If you started the business from scratch, hopefully it has been built up to a profitable venture and you have plenty of equity. If you bought a business and have increased it revenue and profitability, most likely you have increased the overall value of the business (as you have read in past blogs, there are other variables to consider).

What most people are looking for when buying a business are the revenue trends over the last 3-5 years. If the revenues are stable or growing – great. If they are in decline, we need to understand the reasons for it. The reasons for the decline might keep a buyer interested, however, there are more perceived risks associated with a downward trend. This will prove to be a negative impact on business value. One of the other difficulties in selling a business with downward trends: banks willing to finance a business in this situation are an endangered (maybe extinct) species, forcing the seller to become the lender.

Many times we see business owners pass up the opportunity to sell at the high point, and who are instead pressed into selling at the worst time due to age and health concerns. An owner who decides to keep working into their 80’s inspires many of their family, friends, and peers. I’m sure any of us would feel blessed to be able to do that. But too often those companies lose momentum as the owner loses energy and passion and we end up with a distressed business.

Buyers want good businesses with strong trends and business owners can get more for their business when they exhibit strong revenue trends. Hmmm, seems like a winning combination!

Negotiation as a Seller

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SellerNegotiationSome of the sellers we have worked with have the approach that “it’s all or nothing. You WANT my business, you SHOULD want my business and I don’t NEED to negotiate.” Yikes!

Business peers, friends and family might be saying that their business is worth $2 million when the financial statements and other variables show it is really worth about $1 million. The seller can get a lot of advice from people that either don’t understand the situation, don’t have all the details, or have motivations that conflict with the reasonable price for the business. A seller shouldn’t get a price locked into their brain without room for negotiation. There is normally give and take when any deal is done and flexibility is how it happens.

Another important concept is listing age. Some sellers think that there will be a never ending line of prospective buyers. However, the amount of time that a business is on the market can affect buyer interest (and value!). We know this from so many years of doing deals. The first two to three months on the market are critical for buyer activity.

We use a real estate market analogy. A house that is on the market for 4 – 6 weeks usually has a dwindling number of showings because there is an unspoken concern that something is wrong with the house or that it is priced too high. (And I don’t want to be the idiot that buys it.) So proper pricing is critical to get buyers interested and willing to negotiate.

Bottom Line: In order to get your business sold, the business needs to be priced reasonably, and there needs to be give and take. Sellers need to have a good idea of what they really want from the deal and have some room to negotiate. If you or someone you know needs an honest assessment, please talk to one of our Apex Business Advisors.

Value Drivers: Clean and Accurate Financials (Part II)

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Clean and AccurateCurrent Financial position and historical records are the major factors in putting a value on a business. Last week the focus came down to trust issues around the financials. This week we’ll focus on the numbers.

Definition of Cash Flow: owner salary, net profit, depreciation, interest expense, and discretionary expenses not necessary for continuing operations

As mentioned in last week’s blog, the typical business advisor (accountant, financial planner, attorney, banker, business coach, etc.) needs to understand the existing situation and historical information to unlock some mysteries in the business. What are the trends, opportunities, threats? Solid financial information should lead to solid advice.

When selling a business, the marketplace puts a value on the cash flow of the business. Have the cash flows been steady, increasing, or decreasing? Are the cash flows readily apparent in the financial statements? Is the cash flow expected to continue or are there major changes expected? A buyer needs to understand the cash flow in order to make a good offer on a business. That offer takes the following into consideration:

1. Return on the buyer’s initial investment (paying the new owner’s salary),

2. Cash to pay off debt for the acquisition, and

3. Retaining cash in the business to support operations.

A business that shows a cash flow of $100,000 may be able to achieve a market value of 2 or 3 times that amount. Let’s say the value is $300,000 (3x $100,000). Last week I used an example of someone sending a family of 15 on a European vacation. Let’s say that the tax deduction used for that vacation was $25,000, and the tax savings was approximately $7,500. It feels good to save $7,500 on taxes; however, the value of the business went down considerably more than that. A $25,000 expense translates into lost business value of 3 x $25,000, or $75,000!

Sure, there is negotiation, and this is just a simple situation that should be easy to explain to the buyer and the bank. It does illustrate a point, however, that some simple tax dodges to save a few bucks will certainly make a much larger reduction in business value.

Talk to one of our Apex Business Advisors to help you plan and improve the value of your business before it is time to sell.