Deal of a lifetime
How a private business is marketed can have a significant impact on the cash available for distribution to owners when it’s time to sell. For many private investors, their business interests are their primary assets, so their livelihoods often depend on receiving top dollar.
It’s a hot market
In recent years, the hottest industries include health care, financial services, technology, and oil and gas.
However, some opportunistic buyers are looking for deep bargains so business sellers should beware. It’s important to price your company with the help of an experienced valuation professional using current market data. Failure to achieve a full value for the company can lead to seller’s remorse or lawsuits from minority shareholders who dissent to the sale.
The importance of asking price
It’s tempting to rely on industry rules of thumb when setting the asking price for a business. For example, folklore in the manufacturing industry might indicate that a manufacturing company will sell for three to five times earnings.
Sellers are sometimes led to under- or overestimate how much their business is worth because these pricing multiples are simple, but they’re also ambiguous. The example provided leaves many unanswered questions, including:
- What does the term “earnings” mean?
- What does the formula include or exclude?
- Where within (or outside of) the three-to-five range does a specific company fit?
- Do you need to subtract debt or add working capital to arrive at the value of the business?
Real-world, comparable transactions provide a much more meaningful indication of how much the company is worth in today’s volatile marketplace than rules of thumb. A sample of “guideline” transactions can be found by a valuation professional. Then they can convert these guideline transactions into relevant pricing multiples that can withstand scrutiny from minority shareholders who may question the deal.
If comparable transactions aren’t available, the seller may need to perform a discounted cash flow analysis to arrive at the asking price. An outside professional can help calculate a reasonable discount rate based on market evidence, estimate the company’s expected cash flows and make discretionary cash flow adjustments, if necessary.
Consider the buyer’s perspective
Once the asking price is established by sellers, it’s time to solicit potential buyers. Whether they’re venture capitalists, private equity firms, or closely held competitors, prospective buyers will intensely scrutinize business operations and financial results. It’s important that bargaining power be maintained by sellers during due diligence by doing their homework before putting the business on the market.
The buyer’s perspective must be considered, and the seller should compile a package of information for buyers to review. Gather such documents as the last five years of financial statements, marketing collateral, business plans, forecasts and projections, and contracts with key employees, customers, subcontractors and suppliers. Buyers are also likely to ask questions about tax issues, operating risks, and potential threats such as litigation. Sellers should be ready with the answers.
By planning ahead for buyers’ information requests, sellers appear prepared, experienced and credible, thereby expediting the due diligence process. Doing so also allows the seller to cast the presentation of financial and operational information in the most favorable light. They can, for example, play up factors that enhance value and minimize the need for financial statement adjustments, which tend to turn off prospective buyers. In some cases, a seller may decide to settle lawsuits, divest unprofitable business lines or buy out minority shareholders in anticipation of a sale.
Structure the deal
Last but certainly not least, sellers need to think about deal structure and tax issues in advance. In general, sellers tend to prefer stock deals, rather than asset sales, from a tax perspective. However, buyers generally prefer asset sales, which allow them to cherry-pick the most desirable assets and exclude the seller’s liabilities. Installment sales, earnouts, and post deal consulting and noncompete agreements are additional issues to address before negotiating with prospective buyers.
Seek help from a professional
An outside valuation professional can help “market” a for-sale business to maximize its value to selling shareholders. Also, sellers can identify problems and take action to enhance the company’s value by planning ahead.