Vaguely Right or Precisely Wrong about Cash Flow

/in , /by Al Statz

Al StatzWarren Buffet once quoted the economist John Maynard Keynes, “I would rather be vaguely right, than precisely wrong,” in describing how he determines the appropriate cash flow measure of a company.

Indeed, determining the value of a business is not a precise exercise.  However, neither is the process random guesswork. After assessing the facts and circumstances of the business, the appraiser’s goal is to find a value that represents what hypothetical or actual market participants could be expected to pay for the business or an equity interest therein.

When it comes to understanding financial performance, privately held businesses present several challenges not present in public companies. For beginners, private companies are not held to the same financial reporting standards. Hence, financial statement quality varies widely from business to business. Business appraisers and M&A advisors must look at the reported numbers and make a series of adjustments before applying valuation methods. Valuation analysts typically make four types of normalization adjustments to arrive at a true measure of cash flow (or some other economic benefit stream).

Four Types of Normalization Adjustments

  1. GAAP related — typically for comparison with industry peers
  2. Non-recurring and extraordinary items
  3. Non-operating assets, liabilities, income and expense
  4. Control-related — adjusting owner benefits to market or reasonable replacement values

Owners, investors, CPA’s, attorneys, lenders and other market participants are often surprised how much work goes into investigating and adjusting financial statements before business valuation methods can be applied. Often, the smaller and more closely held a business is, the more normalization work will be required.

“Often, the smaller and more closely held a business is, the more normalization work will be required.”

There are other areas where the need for investigation and professional judgement increases in small business valuation. Small private companies seldom have the same quality of systems, and usually have more reliance on few products, employees or customers management, which increases uncertainty and adds to the risk analysis. And they rarely have defensible growth projections. The growth rate and risk score affects the discount or capitalization rate used in the valuation. And using valuation simplistic formulas, “rules of thumb” or hearsay are almost sure to yield precisely wrong results. Whereas, an accredited and experienced appraiser using appropriate valuation analysis, professional judgement, objectivity and common sense will give you an opinion of value that more accurately reflects market reality.

Exit Strategies brings independence and over 100 years of combined professional expertise to every business valuation engagement. Contact Al Statz with any questions or for a free confidential consultation on a potential business valuation or M&A need.

Business Valuation: Step one in the sale process.

/in , , /by Louis Cionci

If you are considering selling your business, I would like to let you in on an M&A (merger and acquisition) professional’s insight. I have been involved in initiating and managing M&A transactions for over 15 years and have handled deals representing over $250 million in transaction value. Those transactions ranged from $2.6 mm to $90 mm. In addition, I was on a team that helped an international client acquire a $2.6 billion industry rival back in 2000.

Whether $2.6 million or $2.6 billion, these successful transactions started with a business valuation.  The sale or acquisition of a business is a multi-step process, and the first step in a successful transaction between a buyer and seller almost always begins with a professional business valuation. Steps that follow the valuation include, marketing the company, buyer due diligence, negotiating the deal, and the closing.
A business valuation is a critical step on both sides of the deal table. Normally, the seller will do the first valuation, to get an idea of their company’s market value and then decide upon a price range that would motivate them to sell. The seller will generally share their historical and projected financial information with a vetted buyer. The buyer can then apply their own specific investment requirements to the shared information. Both sides utilize their valuations to negotiate the deal.
In my experience, no matter the size of the deal, the first step in a successful M&A transaction is a business valuation.
 
For more information on business valuation for M&A transactions, Email Louis Cionci or call him at 707-778-2040.

Valuation: Theory, Practice and Reality

/in , /by Exit Strategies

I attended a luncheon last week where a private equity firm’s panelist claimed that business valuation is too theoretical and inappropriate in the transactional world.  I instinctively question broad-based statements like this, when I hear them; however I listened attentively. The panelist correctly asserted that most valuation firms focus on compliance and litigation work as opposed to transactions. However, his criticism of valuation work was illogical and inconsistent, and offered no better alternative.

To make his case he defined enterprise value in transactional terms as: what it would take to buy 100% (equity + debt) of the company excluding cash, in an arm’s length deal. Okay, so far this was sounding a lot like the willing buyer/willing seller concept of Fair Market Value.

He went on to discuss how firms are typically valued by valuation analysts. These were his assertions:

  1. The income approach, known as discounted cash flow (DCF), is too theoretical. I disagree. This approach seeks to price businesses by assigning a risk-based rate of return to the expected future income. Strategic buyers use the DCF approach whenever they expect non-linear growth in the business. In business valuation we determine value to a strategic buyer under the Investment Value standard. Risk assessment also very similar to what bankers and insurance people do, although evaluating the risk of a going concern involves qualitative assessments that are harder to quantify. Proper application of valuation theory, tempered by common sense can provide clear insight into fundamental value.
  2. Comparable transactions are the most important. This is consistent with business valuation theory, and I agree in concept. In reality, a lack of data and inconsistent reporting of private business transactions makes accurate comparisons difficult. Therefore, this approach is often used as a reality check against income approach results.
  3. The factors used to gauge a company’s debt capacity are very similar to analyzing equity value (like customer concentration, poor systems, etc.). Agreed. Again, it’s pricing the risk of the operation.  A bank won’t lend money to a risky firm, or if they do, terms and pricing will be more stringent. The income approach he decried as “too theoretical,” works the same way.

He went on to discuss the price ranges that he sees in transactions. Typically, he said, adjusted EV/EBITDA multiples range from 3.9 to 6.9. This range can be explained by varying degrees of profit margins, expected growth and risk, as well as potential synergistic benefits. But he gave no indication how to quantify these issues.

In the end, I suspect that the panelist just didn’t understand business valuation very well, and described the world as he sees it through a narrow lens.

Two concluding points:

First, when valuing your life’s work, all reasonable valuation approaches should be considered. One approach may be more appropriate than another. All approaches lend insight into value. It’s not an all or nothing exercise.

Second, don’t trust your business to someone who lacks valuation expertise, someone with a limited point of view, or someone who may have an agenda.

Exit Strategies brings independence and over 100 years of combined valuation and M&A transaction expertise to every engagement. Contact us for a free confidential consultation with one of our senior advisors.

How to Sell Your Business for More Than Fair Market Value

/in , /by Louis Cionci

If you are selling your business and you want the highest possible price, here is one way to get a premium over its Fair Market Value.

First, consider that the value or price an owner can expect to receive for their business is generally a function of: 1) free cash flow generated, 2) growth expectations, and 3) the risk involved in receiving the cash flows. These factors combine to determine the value for the business entity. Expressed another way, the value of a business is the present value of the risk adjusted future cash flows specific to the selling company.

Each company has a unique set of these factors. A Financial buyer is interested in how these factors measure up for the company on a stand-alone basis, and will determine a price that they are willing to pay for the business, or Fair Market Value, relative to their other business investment opportunities, including other businesses for sale. Most buyers are financial buyers.

But there may be another type of buyer looking to buy your business — a Strategic buyer.  This type of buyer has a complementary business, generally in the same industry or a related field, and expects to be able to combine the two companies to achieve synergistic economic benefits. Synergistic economic benefits can take many forms: reduction of expenses through economies of scale, new or complimentary products or services, industry risk diversification, increased market share, customer acquisition, defense of a market position, upstream or downstream vertical integration, increased sales of core products, less expensive than building from scratch, and others.

By combining the two companies, the buyer expects to produce an economic benefit that is greater than that available to the selling company on a stand-alone business. Therein lies your premium to fair market value. The seller is now more valuable by the amount of the expected synergy, to that particular strategic acquirer. The seller’s premium is some portion of the synergistic value. The strategic acquirer can pay a higher price than FMV because they see more value in the selling company. In addition, the strategic buyer is generally motivated to achieve the strategic benefit. This provides the seller with some leverage, and helps the process to achieve a successful completion, particularly when the seller’s M&A advisor brings multiple strategic buyers to the table.
 
Identifying, educating and motivating strategic buyers is one of the many facets of successful M&A brokerage work. For more information on strategic buyers or the M&A selling process, Email Louis Cionci or call 707-778-2040.

The Dismal D’s of Buy-Sell Agreements

/in , , /by Al Statz

Well-written Buy-Sell Agreements (BSA’s) enable orderly share transfers upon the occurrence of certain events during the life of a business. Buy-Sell Agreements also prevent litigation that can quickly create a lose-lose situation for business owners. This article presents a list of 27 trigger events and common issues to be addressed in Buy-Sell Agreements. And, just for fun, each item on the list begins with “D”.

Buy-sell issues are unpleasant to think about; which is why owners often put off addressing them and why we call them Dismal D’s. However, it’s only good business to put a plan in place that protects company and shareholder interests when these events occur.  And they will occur.

Buy-Sell Agreement Dismal D List

  1. Departure (quits or leaves)
  2. Disinterest (mentally but not physically leaves)
  3. Discharge (fired)
  4. Divorce
  5. Death
  6. Disagreement
  7. Deadlock (major disagreement)
  8. Disability
  9. Distress (within the business)
  10. Default (personal bankruptcy)
  11. Disqualification (licensing, regulatory, etc.)
  12. Disclose (confidentiality)
  13. Donation (donate or gift stock)
  14. Do not compete
  15. Dual entities (e.g. holding and operating)
  16. Dilution
  17. Drag-along rights
  18. Distribution policy
  19. Dividends and Distributions after a trigger
  20. Dispute resolution
  21. Death benefits (life insurance)
  22. Down payment and debt (buyout financing)
  23. Determination of value (fixed price, formula, or independent valuation)
  24. Defining elements of any valuation engagement
  25. Discounts (for minority interests)
  26. Different discounts (depending on trigger type)
  27. Dueling appraisers

Items #1-14 are common trigger events. Items #15-27 are common issues to be negotiated and addressed in the BSA. Items #22-27 are nearest and dearest to our hearts as business valuation experts. Arguably, valuation is the most important (and argued over) aspect of buy-sell transactions.

The above list is essentially a checklist for consideration by shareholders when creating or reevaluating a Buy-Sell Agreement. Owners should work with their partners, corporate attorney, CPA and business appraiser to understand and address all of these issues.  “Daunting D List” may be a better description!

Not only is it critical to have a BSA (yes, many businesses don’t have one), but it’s also vital that the BSA be kept up to date. Owners come and go. Shareholders’ personal, family and financial circumstances change over time. Likewise, businesses are not static and economic and industry conditions, services offered, customers, management depth competition are in a constant state of flux – all key factors in business valuation.

Click here for more information on how Exit Strategies’ helps with buy-sell agreements.

Business valuation plays a central role in buy-sell transactions and buy-sell agreements. Contact one of Exit Strategies’ senior advisors with any questions or for a no obligation, no cost and confidential consultation.

Exit Planning: A New Year’s Resolution

/in , , /by Al Statz
“Expect the best, plan for the worst, and prepare to be surprised.” – Dennis Waitley
This is the time of year when many of us decide that we need to change things or accomplish new things, and we set goals at the beginning of the New Year. Quit smoking; lose weight; make more money? How about taking a look at your business this year and begin to prepare it for your exit, which will ultimately arrive whether you’re ready or not.  Surveys have shown 75% of business owners have done little or no exit planning. Owners that do plan ahead are more likely to attract buyers and obtain a higher selling price. Here are some key steps to take this year:
1. Clean up financial records.
  • End commingling of expenses, assets & liabilities. This may result in increased tax liability, but will more than pay for itself by returning a higher sale price. Example: suppose you wanted to sell your businesses in 3 years. If the market multiple of EBITDA (Earnings Before Interest, Taxes Depreciation & Amortization) is 4, for every extra $1 of EBITDA you show on the bottom line, you receive an extra $4 in the selling price.
  • Declare all sales revenue.
  • Sensible, consistent, GAAP financial statements (from the buyer’s CPA prospective).
  • Normalize each of your financial statements. Make notes below each of your year-end statements regarding expenses that are non-recurring in nature, or one-time expenses that are not normal in your business operation.
  • Control expenses: if you have a corporation, take a look at your salary, perquisites and benefits. Decide what it would cost if you had to replace your services with someone else. A business broker/appraiser would make this adjustment to arrive at a modified level of earnings that is commensurate with market rates of compensation. If you have more than one owner working in the business, adjust the salary, perquisites and benefits for each of the owners.
  • If you personally own the building that houses your operation and the corporation or LLC pays rent to you, check to see that the rent is at a market rate. Differences between market rent and actual rent being paid will adjust EBITDA.
  • Pay all of your taxes on time; sales, personal property, payroll, etc.
  • Maintain sensible, accurate management reports.
2. Systems, policies and practices.
  • A well-documented operation pays off by adding intangible value from a buyer perspective.
  • Develop or update systems – and have detailed documentation for all processes your business performs.
  • Measure, report and act on key performance indicators
  • Develop or update employee manuals, policies and job descriptions  for each employee.
3. Personal Goodwill.
Depending upon the type of business and your role in it, take a hard look at your involvement with customers. If most of them do business with the organization because of personal relationships with you, begin to transfer these relationships to someone else or a new hire in your organization. From a value perspective, goodwill that is attached to you is more difficult to transfer to a buyer than goodwill attached to the enterprise.
4. Customer Concentration.
Take a look at your top 10 customers and the percentage of revenues and gross profits that each customer generates. A high concentration of business with a small number of customers will have a negative effect on value. One way to correct high concentration levels is to increase the size of the customer base.
For advice on exiting your company feel free to contact Bob Altieri at 916-905-5706 or boba@exitstrategiesgroup.com. 

February Seminars: Maximize the Value of Your Business

/in , , /by Al Statz
Now in its 9th year, Exit Strategies’ Maximizing the Value of Your Business seminar delivers essential and practical information to business owners who would like to sell for top dollar in the next 1-5 years.  It is not too early to plan the successful exit you deserve!
In this fast-paced workshop, business owners learn …
  • The elements of an effective exit strategy
  • Types of buyers and what they value
  • Business valuation nuts and bolts
  • How to increase valuable and marketability
  • M&A selling process steps and timeframes
  • Current market conditions
  • Deal structures and tax implications
  • The secret to cashing out
  • What a professional M&A broker brings to the table
  • Answers to your questions and concerns
This seminar is complimentary to owners of $1-30 million revenue businesses
 
Dates: Petaluma – Tuesday, February 10, 2015
Roseville – Tuesday, February 24, 2015
Time: 4:00 to 6:30 pm
Presented by: Exit Strategies senior-level advisors and a guest speaker
Register:
Petaluma:  707-778-2040, info@exitstrategiesgroup.com
Roseville:  916-800-2716, info@exitstrategiesgroup.com
Space is limited. For privacy, we allow just one owner (or set of partners) per business type. When we confirm your registration we will provide the location address. Schedule conflict? Contact us to be notified of future dates.
“Amazing amount of information that I can use immediately. You made a complex topic clear and easy to grasp.”  -KM
“Everything that you said would happen when we sold our business happened, and we were prepared. Thank you.” –TB
Because you only sell your business once!

– See more at: https://web.archive.org/web/20150212225951/https://exitstrategiesgroup.com/blog.html#sthash.IDVsikiL.dpuf

Your December Checklist for a 2015 Business Sale

/in , /by Don Ross
Thinking of selling in 2015? Here are ten actions you can take this month to achieve a higher price in the New Year. 
  1. Finish 2014 strong.  Buyers and their lenders will want to see your last full fiscal year profits on an uptick. Ship and invoice everything you should this month. Resist artificially pushing income into next year to reduce your tax bill.  Don’t go nuts prepaying expenses like monthly service contracts, retainers or rent.  Review the functional health of fixed assets.  They should be in good working order – after all you’re still in business – but refrain from replacing good with new this December.
  2. Sell off non performing assets. Assets that aren’t being used productively in a business reduce its return on assets. And, it can be hard to convince buyers that such assets aren’t necessary. If they aren’t necessary, dispose of them now and get them off of your balance sheet. Also, you’ll generate extra cash now that you probably wouldn’t get in a sale of the business.
  3. Assess inventory levels.  If your inventory turns are below industry norms, convert excess or slow moving inventory to cash. Write off any dead inventory that may be lingering on the books.  Why? Simply put, buyers buy cash flow, not inventory.  A one-time inventory write off is relatively easy to explain, and you won’t get paid for it in a sale. Also, Now is the time to take a physical inventory count (rather than estimate), and adjust your books accordingly.
  4. Have your CPA review the financials.  For those of you who haven’t prioritized accounting in the past, now’s the time! Are year-end CPA-provided expenses such as depreciation reflected in the income statement?  Are all “suspense” accounts eliminated and properly attributed to the right accounts?  Are divestitures of fixed assets removed from the balance sheet?  Are the financials verifiable against federal tax returns? Are capital leases correctly accounted for? Does the balance sheet make sense? Will your accounting make sense to a buyer’s accountant in due diligence?  Why is this important? As business brokers, over and over we see good buyers and lenders turned off by shoddy accounting.
  5. Pay as much as you can in taxes this year.  No, this is not a typo! Why? “Lifestyle entrepreneurs” who hide profits and pull everything they can out of their business often find it difficult to sell that business for a good price.  Entrepreneurs who pay the tax can usually sell the business at a multiple of earnings that well exceeds the additional taxes they shelled out. Explain to your CPA that you are selling in 2015; they should understand.
  6. Prepare the tax returns early.  Close the books and turn them over to your CPA as soon as possible after year end. Why? Business acquisition lenders need to see tax returns, and we can get an early jump on having your business preapproved for financing if the 2014 tax return is prepared.
  7. “Tend the Herd”.  If your business has customers under contract, find ways to extend those contracts.  If your customer portfolio is limited and you have one or two major clients that comprise a large share of your business, aggressively pursue new clients for better diversification.  The same is true with vendors.  Why? This reduces risk for buyers (and you), and business value is inversely proportional to risk.
  8. Update your business plan.  Why is this important if you’re selling? Buyers prefer to see business-as-usual while a business is for sale — especially buyers who are willing to pay top dollar. Businesses with a clear and compelling growth plan sell for more money.
  9. Assemble your transition team.  Consistent success in business sales requires A) an organized process, and B) expertise that few business owners have.  Assemble a team that includes at minimum a competent business/M&A broker, wealth manager, business transaction attorney and accountant. Pay for their advice and let them collaborate. You receive more in the end when you use the best advisors from the very beginning.
  10. Plan for your future.  Beyond the business sale, there is your next adventure to ponder.  Look forward to it. Find time during December to plan for it – with your transition team, so that you can enjoy it when the time comes.
Successful entrepreneurs plan their exit and sell from a position of strength, on their terms and time frame. For more information on any of the above points, or to sell your Northern California business, contact Don Ross at 707-778-0210.

Your Buy-Sell Agreement – Keep It Current Before It Costs You Money and Grief!

/in , , /by Exit Strategies

Buy-Sell agreements (BSA’s) are an essential, and often overlooked, element in allowing shareholders to realize the value of their investment in a privately held company. The BSA’s purpose is to a) provide a market for ownership interests, b) establish the price and terms for these interests, c) specify a buy-sell process that is orderly and reasonable, and d) specify financing should a “trigger” event occur. There are several reasons this contract among owners can fail. Let’s briefly examine a few reasons why this can occur and it will become obvious why this document needs to “live and breathe” outside the confines of the corporate archives.

A BSA that is written upon entity formation, even if well-articulated, becomes less relevant as time marches on.  This happens for myriad reasons ranging from changes in business conditions and value, or changes in an owners personal situation or objectives. Language in BSA’s is often not sufficiently precise and leaves too much room for interpretation that can result in shareholder disputes and costly litigation that dilutes value for all shareholders.

There are three types of BSA’s: fixed price; formula pricing; and valuation process. Business valuation is a function of economic conditions and business fundamentals. Of the three BSA types, only the valuation process is flexible enough to fully accommodate the range of changes that can occur in a business. Fixed price and formula driven valuations may be less expensive to execute, but they are simplistic and can omit key value determinants that ultimately can prove very costly.

There are a wide range of trigger events where an owner may quit, be fired, retire, die, be disabled, or get divorced to name only a few. Each trigger event can alter the personal objectives of one or more owners, impact the business, and may have both control and valuation implications for all concerned parties.

Template-driven BSA’s frequently either omit, or do not make a clear distinction on the standard of value to be used in calculating value. For example, the difference between using an investment value standard or a fair market value standard can be very large. If the standard is not clear in the BSA, a buyer would naturally assume the lower price implied in the fair market value standard, while a seller would assume the higher price found in the investment value. Hence, if the BSA does not clearly address this issue, conflict and costly litigation is a likely outcome. Similarly, the level of value also has valuation implications that create potential for conflict if not clearly addressed in the BSA, because the difference between a controlling interest and a minority interests can be substantial.

As is now readily apparent, a well-defined and current BSA is important to accurately allocate value and keep the peace! Key elements of the BSA should seem reasonable to all owners BEFORE a trigger event (before the parties know if they will be a buyer or a seller), when it is easier to reach consensus. AFTER a trigger event this becomes difficult since there is an inherent conflict between a buyer and a seller.

Business valuation plays a central role in Buy-Sell Agreements. For more information about Exit Strategies’ BSA-related services contact one of our senior business appraisers.

Don’t be a Victim of Seller’s Remorse

/in , /by Jim Leonhard
More business owners than you’d think second-guess themselves within a year of selling the business.  In my experience as an M&A advisor and business valuation expert, the main reason for the failure of business exits is the seller’s lack of planning on how and when to exit.  Too many owners never plan and simply wait until something happens that essentially forces them to sell, such as health issues, marital stresses, poor business conditions, or when “burnout” becomes unbearable. This is usually the worst time to sell — and the results are usually disappointing.
If you are approaching retirement, start proactively planning for it well ahead of time (3-5 years) while things are going well and while you have time to make and reap the benefits of course corrections.  Have the business professionally valued when you start to plan.  This will give you a sound basis for knowing what your business is worth, and understanding its strengths and weaknesses from strategic and financial investor perspectives.  If the value of the company is equal to or greater than you need or want, you can take steps to keep it that way and protect against contingencies.  If the value is less than you need or want, you have time to construct and implement a plan to increase value and reduce investor risk.
Your plan can then ensure that you exit on your time frame, maximize value regardless of the situation, minimize taxes, and reach your personal goals.
For more information about preparing to sell and exiting your business successfully, please contact Jim Leonhard at 916-800-2716 or jhleonhard@exitstrategiesgroup.com.