OCT 28, 2015 @ 09:00 AM
GUEST POST WRITTEN BY
David Ryan
Not long ago, I got a call from a business owner who runs a produce company in Southern California. Her husband, who had run the business with her, had been killed in an accident, and she wanted to sell the company. It had been doing close to $50 million in annual revenue at its peak but now was down to about $30 million.
The business owner was expecting to get $30 million for it. That was its valuation when I had talked with her and her husband 15 years earlier—and they decided to hold onto it.
Since then, however, things had changed. The business was no longer profitable. The owner was willing to do some hard work to fix that, and she spent six to eight months getting the company to profitability before we approached some potential buyers. Still, I warned her, the company’s situation was dramatically different. One thing that hurt the business was that some key managers had left to work for competing businesses and several major accounts—worth about $20 million—departed with them.
This time around, the only offer she got was for $7 million. Shocked by how much the company’s value had declined, she said no to it and is doing more work to rebuild the value of her business before she sells—such as shoring up her customer base.
This isn’t an isolated case. Many owners call me after reading statistics showing that it’s a good time to sell a business. But like this owner, they discover their business is worth less in the eyes of potential buyers than they thought—if they get any bites at all. BizBuySell has a current inventory of 45,000 businesses in its database, but just 1,814 deals closed in the third quarter of 2015.
If you’d like to sell your business soon, it is important to do the right work to make your business attractive to potential buyers. That means letting go of any illusions you’re harboring about what makes it valuable and focusing on things that a potential purchaser will really prize.
Avoid these three common self-delusions and you’ll put yourself in a stronger position to sell.
Self-Delusion #1: “My client list is very valuable.” Not long ago I got a call from the widow of a CPA who had passed away. He had always planned to sell client list to another local accounting firm when the time came to retire. Expecting to use some of the proceeds for living expenses, she was ready to carry out his plan.
Unfortunately, that plan wasn’t bulletproof. When I phoned a few CPAs in the local area to assess their interest, no one wanted the accountant’s customers! As it turned out, he was known as a low-cost leader. Why would they want new accounts that would pay them less than they were getting now? One accountant told me flat out that he was better off just waiting until the clients of the deceased CPA approached him—so he could set his own prices with them. I didn’t see how I could sell his business and opted out of working with his widow.
The lesson here is that having an active client list is not enough to make a business valuable. Generally, you need to show buyers you have recurring clients who are willing to pay at least market rates to interest them in paying you for access to those customers. If you haven’t raised your rates in a while, speak with your local trade organization to find out what the prevailing ones are for your local area. If you are on the low end, you will probably need to raise your prices gradually, over a period of several years, to position your firm for a future sale.
Self-delusion #2: “Buyers only care about my revenue.” About two years ago, I heard from the owner of a company that makes equipment used in dumps. He thought the business was worth $2 million, based on its healthy revenue, and wanted to sell it.
Not so fast, I told him. For one thing, his accounting practices were a mess. That is an immediate turnoff to a buyer. Plus, his cash flow was poor and he was barely turning a profit. No one wants to buy a business with low margins. I suggested he get a professional valuation. From what I could see, the business was probably worth closer to $1.2 million in the eyes of a buyer.
He took what I said to heart. Recently, I heard back from him. His accountant had cleaned up his books, and he had fired a low-performing sales person, whose salary had been a drag on his profits. Now the business had better cash flow and was more profitable. He is ready to go to market and has a very good shot at getting the $2 million he wants.
Self-delusion #3: “This business is worth a multiple of X.” Potential sellers often tell me the multiple they want to get for their business when I first meet them–often because someone on the golf course has bragged about selling their business for that same multiple. I always ask “A multiple of what?”
Often, they’ll say, “EBITDA” (earnings before interest, taxes, depreciation and amortization)—and may even say, “Adjusted EBITDA.” But they fall silent when I ask “Does this include working capital?”
That’s an important question. Working capital is a measure of your business’s current assets (cash, accounts receivable and inventory) minus its accounts payable. It is traditionally not included for deals of $2 million or under. If it is included, the multiple may decline by a factor of one. That can have a big impact on a transaction.
Let’s say the selling price for your business is $1.5 million—a 3x multiple of your $500,000 in cash flow. You have $500,000 in current assets and owe vendors $250,000, so your working capital is $250,000.
If you do not include working capital in the sales price, you, as the seller, will get to keep that $250,000. When the business sells, you’ll get the $1.5 million, plus the $250,000. That means you are really getting $1.75 million for your business. That is a multiple of 3.5, so you will get an extra half a multiple than you would if you had included working capital.
The upshot? Before you sell, ask your business broker to walk you through exactly how businesses in your industry are valued. That way you won’t just be guessing at an asking price and can make a realistic deal. (This stuff gets confusing so don’t be shy about asking your broker to explain it a second time—and put it on paper—so you truly understand it. Otherwise, you’ll be at a disadvantage when you sell.)
The hard work and planning it takes to sell a business can be a bit daunting, when you first consider it. But look at it this way: At least you’ll have a chance to make some money from the sale of your business. Many owners live in a world of self-delusion and never sell—and they miss the opportunity to reap the rewards of all of their hard work.
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For additional information regarding Florida business sales, acquisitions and valuations, please contact Eric J. Gall at Eric@EdisonAvenue.com or 239.738.6227. Also, visit our Edison Avenue website at www.EdisonAvenue.com or my personal website at www.BuySellFLbiz.com.
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