Business Valuation from a Buyer’s Perspective
Public company data is often used for a business valuation. This data usually requires substantial adjustments to offset the risks inherent in the company. These potential risks are usually overlooked by sellers, but not by potential buyers.
Obviously, business sellers see their company much differently than potential buyers do. Business owners tend to put value on different factors than a buyer does. When selling your business, it is important to consider important factors for a buyer.
Interviews with potential buyers is a great way to find out what they are concerned with, and influenced by during the decision making process. It is often the most basic things that determine whether they actually buy your business or not and the price they offer.
Buyers tend to look at certain elements as risk factors when figuring expected future earnings. The following factors affect both future earnings potential and the risks involved in a target business.
Business Historical Earnings
A business’s earnings history is very important to a potential buyer. Buyers look for a long history of stable and increasing earnings as opposed to a year or less of erratic earnings.
A start-up business (in business for a year or less) is difficult to sell, even under the best circumstances. If your business has been open for 3 years, a history and track record is just beginning but, you have a slightly better chance of selling it. A business with a minimum of 5 years in the running, finally has a reasonable history of performance for potential buyers to consider. If you have a favorable earnings history after 5 years, your chances of selling your business increases greatly.
Business and Industry Growth
If a potential buyer is from the same industry, then he or she should already be aware of the market and potential issues. On the other hand, if the buyer is from a different industry or business type, then the following issues may be of great importance. If your business is considered to be in a growth industry, the business valuation can be considerably higher, depending on the following issues.
Business Management: A business that is primarily dependent on the owner will bring substantially less in the marketplace than one that has key management personnel in place. Many potential buyers want experienced management in place.
Concerns about management may include:
- Will top management stay beyond any contractual periods?
- Is the current management motivated and what incentives do they need?
- Are current management values, etc., consistent with the buyer’s?
- Does current management have the leadership skills to move the company forward?
- Is the depth of current management sufficient to fulfill projected growth plans?
- Is current management able to handle change?
Employee Stability: Having a skilled and happy workforce in place is especially important for new owners who don’t have experience in the industry. Potential buyers are equally concerned with the high-cost of finding, hiring and training new employees. Companies with a well-trained, skilled and contented workforce will command a premium business valuation. Companies with low-skilled employees and a high employee turnover rate will be of much lower value.
Terms of Sale
Is the company solid enough to support debt financing as opposed to equity capital? Are the company owners, if privately owned, willing to help finance the acquisition? The answers to these
questions directly impact your business valuation. The availability of capital can be a significant factor to a potential buyer.
Two Elements of Diversification
- The first is the diversification of products or services. Can the business be readily expanded? Do the products or services only fulfill the demand of a small market, therefore limiting expansion? What limitations does the company have, such as customer or supplier restrictions?
- The second element is geographic. Providing the product or service on a national level certainly increases value and decreases the risk to the buyer. Conversely, only local or regional distribution reduces value and increases risk for potential buyers.
Heavy competition can lead to lower product and service prices, resulting in lower profits. The exception to this is concentrated competition. For some businesses, such as auto dealers, clustering in auto malls can actually increase sales.
Some industries seem to be simply more “popular” than others. Manufacturing represents less than 10 percent of all businesses, but the demand for this type of business is very high. Conversely, the demand for retail businesses that must compete with the large “box” stores is very low.
A strategically-located business will, at least psychologically, increase value. Well-maintained fixtures and equipment will definitely increase value.
Common Mistakes in Business Valuation
Not really defining what is for sale– Are all of the trademarks, copyrights, patents or other intangibles included in the sale price? For example, in the sale of a fast food chain, are the proverbial “secret recipes” included in the transaction price?
Forgetting favorable attributes– A stone quarry may have one of the few available permits to excavate in a particular state or county, or a distribution business may own exclusive territorial rights, etc. These attributes should result in a premium business valuation.
Not discovering the true level of earnings– Making accurate adjustments to earnings (normalization) is essential to recognizing the real earning power of a business.
Not finding value detractors– No business is perfect. Is the equipment antiquated? Are the financial statements in disarray? Will significant capital expenditures be required in the near future? Consideration must be given to the impact of potential value detractors such as those listed above.
Forgetting the real value of the assets– It is easy to forget that particular balance sheet items may be worth more than their indicated book values. For example, capital equipment may have been depreciated to an amount significantly under its actual value.
Selecting the incorrect earning period to capitalize or discount– Are they last year’s earnings, an average of the past few years, or merely a projection of next year’s earnings? Historical earnings cannot be used if future earnings are expected to be substantially different.
Choosing an inappropriate multiple or capitalization rate– Is it applied to EBIT or EBITDA and why? How was the multiple derived? Today’s EBITDA multiple is not necessarily tomorrow’s!
Not considering current market conditions– The current business climate and economy can significantly impact business valuations. Changes in overall market conditions can cause business valuations to fluctuate substantially.
There is a considerable amount of knowledge and work that goes into business valuation. Make sure you know what your business is really worth before you sell. Contact Florida Business Brokers today for a free business valuation.