My Friend’s Company Sold for 4 Mil, So Mine Has To Be Worth 5 Mil!
The big wave is coming! Like many other facets of society the “Baby Boom Generation” will have a tremendous impact on the small business environment in the United States.
Big Dreams or Big Nightmare?
It is estimated “over the next decade, six out of ten U.S. business owners plan to sell their companies – a noticeable increase over previous years. Many are baby-boomers, with an eye on selling their businesses to fund their retirement.” (Source: BizBuySell.com)
The challenges for potential sellers are twofold:
- Many small business owners are preparing to sell their operations during a period of unprecedented competition. The sheer volume of businesses that hit the market due to aging boomers looking to cash out for retirement will mean that potential buyers will have a multitude of opportunities to choose from. More supply of businesses for sale with fewer potential buyers will inevitably lead to downward pressure on prices.
- It is a commonly held belief that many business owners are not adequately prepared to sell their businesses. Unlike real estate or stocks, closely held businesses require 1 to 2 years or more of planning to sell and owners must continue to build value even after the decision has been made to list the company for sale. This may be counter-intuitive thinking for business owners who have made the decision to sell and who may be applying the brakes on their businesses at the most inopportune time.
Unrealistic Expectations: Are You Sane or Delusional?
The biggest challenge for “boomer business owners” however may lie with completely unrealistic expectations as to the value of their companies. Most small business owners do not know how to properly value their businesses and many grasp onto delusional valuation figures based upon money invested into the business or worse on their needs for retirement.
Noted small business coach John F. Dini provides a great example as to how and why company owners place unrealistic valuations on their firms.
An owner runs into a long-time colleague at a trade show. In reply to the “What’s new?” question his friend says “Well, I just sold my company. I got $ 4,000,000.” The owner knows that his company is about 25% larger than his friend’s, so $ 5,000,000 must clearly be his market value.
Any seller will always claim the highest number he can justify. After a lifetime of building a business, our egos are heavily invested in the bragging rights. The pleasure lies in telling the number, not presenting the details. So that $ 4,000,000 includes assumption of the company’s $ 700,000 working capital line, purchase of $ 1,000,000 in accounts receivable (which were collectable by the seller anyway), and payout of $ 500,000 in loans that the owner made to his company with post-tax dollars. Of the remaining $ 1,800,000, some may be conditional on future company performance, tied to continuing employment, in the form of an installment note, or in restricted stock.
Yet our business owner confidently walks away knowing that his company is worth $ 5,000,000. It must be accurate, since his friend wouldn’t lie and that selling price was determined in an arms-length transaction. Our owner begins planning his future around the day he receives a check for $ 5,000,000. (Source: Awakeat2oclock.com)
When it comes time to sell many business owners will be SHOCKED to find how little value they may have in their company and be completely underfunded when it comes to their retirement needs because they put all of “their eggs in that basket.”
Business Valuation: Part Art and Part Science
Many valuation experts and business brokers commonly start with a multiple of gross revenues to place a sales price on a company. However, this is just a starting point to the discussion as there are many different factors that go into placing a value on a small closely held business.
All companies have different moving parts and no two are alike. Factors that should be considered when placing a sale price on a business include:
- Dependence on a handful of customers
- Financial structure, level of indebtedness
- Historical growth rates of the business
- Quality of product pipeline
- Competence of second tier management
- Market share
- Minimum size, attractive valuations are difficult to achieve when sales are less than $ 10m.
- Sales pipeline
- Share structure
- One year of losses will require at least 2 great years of profits immediately after those losses
Owners must dig deeper to unlock the true value or kick start it into action, because in the grand scheme of things it is not what the owner thinks the business is worth, but what someone is willing to pay for the business that matters.
Is a potential investor going to look favorably at a company with stagnant sales, one or two customers providing 10%-20% of revenues and is not considered somewhat of a leader in their industry?
Where is the value that will make your business the one to buy?
Where Do We Go From Here?
Those businesses that carefully plan for their ultimate exit will be the most attractive in a crowded marketplace. Those that do not give careful attention to their exit plans may find themselves holding a fire sale for their companies, or worse simply folding up the tent and going home.
To sell a business in the coming years, owners must be able to determine what would make their businesses attractive to prospective buyers and begin their planning process with that in mind. Owners must also focus on growing the key drivers of their businesses and invest in sales, marketing and business infrastructure if necessary.
The BOTTOM LINE for business owners planning on listing their businesses in the near future (within 5 years), it is vital that the process begin NOW!