Ready to Sell - Part V: Valuation
Our 5-part series Ready to Sell is designed to help start the conversation around things every business owner should be thinking about before they start the sale process.
Part V: Valuation
Every business owner wants to know what their business is worth.
There are a lot of ways to try and answer the question, because valuation can be a very complex question. We could be talking about anything from “book value” to “fair value” to “market value” or perhaps valuation in the context of tax or estate planning. Maybe you’ve run a DCF, analyzed the comparable transactions. Or maybe you just have a price where you’d be willing to move on. It gets complicated quickly.
Let’s simplify things: What is my business worth if I want to sell it?
No matter how you think about valuation, there's an obvious answer to this question. No, it’s not what the DCF tells you, it's not the average of the transaction comps, and it may not even be what the banker says in the pitch meeting.
Your business is worth what a buyer will pay for it.
If there’s no buyer willing to pay the price you set – no matter how you come up with that price – your business is not worth that price. And the price a buyer will pay can fluctuate depending on market conditions, or many other factors.
So…how do you know what a buyer will pay?
Absent a line of buyers knocking on the front door to make you an offer, the best way to estimate your valuation is to start with one or more traditional valuation methodologies, such as Precedent Transaction Comparables or a Discounted Cash Flow model. (There are others, but for sellers, these are arguably the most common and the most relevant.)
Applying any traditional valuation methodology requires assumptions and estimates, perspective on the future of the business, market conditions, competition, buyer behavior, economic cycles, and many other subjective elements. You need relevant context to determine how to adjust for the unique elements of your business, for the market environment. Think of traditional valuation methodologies as a guide, not a verdict. Every business, every transaction is different, which is why context is so critical.
Consider this example (perhaps a cautionary tale):
Many years ago, we worked with a client running a successful family business. The founder was ready to retire, the adult children were not ready or interested in running the business, so the founder decided to sell. We asked him what he thought the value of the business was – and he answered by listing all the family members he wanted to take care of and how much money he wanted to give each of them. He added all that up, and that’s how he decided what his business was worth to him. When we looked at the relevant transaction comparables, a recent failed deal in the marketplace suggested that his target price was probably at least 40% high.
Nevertheless our founder persisted. After over 2 years talking to prospective buyers, he started to realize there was not going to be a deal at his target price. He retreated, reset his target price to match the market, and finally we did complete the transaction. Unfortunately that lesson cost over 2 years of lost time, and the deal came at a steep discount to his original hopes.
This is pretty far from an ideal situation – and one that can be avoided. You want to understand the relationship between valuation – the highest price a buyer will pay for a business – and your target price – the price where you are a willing seller. If there’s a wide gap between these two numbers, now might not be the right time to sell, you may need time to take action that will bring the valuation and target price closer together. Balance is important, so you don’t leave money on the table or end up with no deal but plenty of wasted time, effort and money.
3 steps we recommend sellers take to understand their valuation, and achieve it in a transaction:
1. Establish your target price – again, what valuation needs to be for you to be a willing seller.
As you think about your target price, solicit feedback from trusted advisors. Is your target price, your approach practical? What would it take to achieve that target price in a transaction? Think about your preferred timetable to close a deal. How soon do you want to sell? Your business may not be worth your target price today – but it can be with solid execution and management.
2. Establish a realistic, practical view of your valuation – what would a buyer pay for your business is today, as it is now.
Run a DCF, look at transaction comparables, get advice from advisors who work on M&A transactions professionally. Be realistic about your inputs, assumptions – the DCF is heavily dependent on the variables and won’t be useful if your inputs and assumptions are not realistic and achievable.
Transaction comparables capture market activity – deals that were actually completed. Layer in context – how your business compares to the ones that sold. Look at growth, margin, scale, market conditions, and other factors to understand whether your business is likely to sell at a premium or discount to what the comps indicate.
Keep these analyses current, update them frequently, get outside feedback on the variables and deal comps.
3. Develop a strategic and operational plan to get from the current valuation to your target price.
If your target price is $25 million, and the analysis you’ve done suggests a buyer would pay $15 million now, you’re probably going to need to plan for growth and / or margin expansion to hit that target price. How will you grow – new products, new markets, acquisitions? What operational improvements will you make to expand margins, generate more cash? If your preferred timetable doesn’t provide enough runway to achieve your target price, what adjustment(s) will you make – extend the timeline, lower expectations, take additional action to improve operations, some combination of these?
When you’re taking stock of your business, try to assess key attributes quantitatively – the numbers don’t lie. Where a qualitative assessment is the best you can do, be objective, be realistic. Put yourself in the buyer’s shoes – will they agree with your view of the brand strength? Of the quality of the product portfolio? Can you show data and metrics to substantiate the subjective elements?
If valuation really is the highest price a buyer is willing to pay, the best way to maximize your valuation is to keep emotion out of the equation. Make your case with data, be objective about how your business compares, and know the market backdrop. And if the valuation doesn’t match your target price, start thinking about what actions you will take to bridge the gap.
Bonus tracks:
1. How might a banker help?
A good banker will market your business to the right potential buyers, and provide 2 key benefits: First, a banker – especially one with deep experience in your industry – can identify and amplify the key business highlights that will resonate with potential buyers, and help you reach potential buyers who may not have even been on your radar. Don’t expect your banker to work miracles, but a good banker can help to enhance the value you receive by validating the most attractive attributes of your business. Second, hiring a banker to lead your transaction can create a signaling effect. Bankers negotiate deals for a living, so bringing one on can indicate a competitive that the transaction process is competitive, driving potential buyers to bid more aggressively and move more quickly.
2. Don't ignore deal structure.
All deals are not created equal – deal structure is critical. Expect some of the consideration to be deferred, some of it to be contingent. Deferred consideration has a timing risk (and possibly market risk), and contingent consideration could have timing, market and execution risk. We always advise clients to look at the baseline valuation – before any contingent consideration such as earnouts, future royalty streams, etc. – as they evaluate offers. “Cash at Closing,” because everything else is either coming later, or coming later only if you hit the target(s). Financial buyers often use more structural elements but expect any buyer to do whatever they can to de-risk their investment in your business.
In this series “Ready to Sell” we’ve explored:
Financials
Deal Team
Finding the Right Buyer
The Transaction Timeline
Let us know what you think – share your thoughts, feedback and tips in the comments or get in touch to start your preparation process at info@amplify-cs.com.