Business owners, advisors, and buyers frequently have widely different impressions of value when it comes to a business.
The Pepperdine Private Capital Markets Survey canvasses intermediaries who sell privately held Main Street and mid-market companies. One question is about the obstacles that prevented the sale of a business. The number one response is “Owners’ unreasonable expectations of value.”
That may be self-serving or an excuse. Nonetheless, valuation is a sensitive subject. Many owners have worked in the business for 30 or 40 years. They assume it will fund their next 20 years of retirement. Their target price is set only by their desired lifestyle after the business.
Different Values for the Same Business
Unfortunately, many owners have an opinion about the value of their business that is grounded in the multiples of public companies. Others are based on conversations with colleagues, salespeople, and articles in their trade publications.
Even those who have professional appraisals of their business may not understand that the purpose for getting your valuation may skew the results. Valuations that are done for estate planning or internal transfers of equity often have little resemblance to a company’s fair market value.
Various people including H.L. Hunt and Ted Turner have said “Money is just a way of keeping score.” For many owners, the emotional tie between the perceived value of their company and their self-image of success is closely connected.
Some advisors skirt this issue by recommending that their clients get a professional opinion of the fair market value of the business. While this is certainly a safe approach, it can take substantial time. It also requires considerable assembly of the underlying data for the appraiser. This can slow down any consulting project considerably and may derail it entirely.
Impressions of Value
A coaching approach helps the owner understand the practical boundaries surrounding the value of the company without either dictating to him or taking the project in a tangential direction. We do that by helping the client model “lendable value.”
We start by explaining that most businesses are valued by their cash flow. There are certainly many areas where value can be enhanced. These include intellectual property, exclusive rights to a product, protected sales territory or long-term contracts. Owner Centricity™ or customer concentration can also reduce the fair market pricing of your business. In the final analysis, however, cash flow to pay an acquisition loan is of principal concern to a lender.
SBA minimums for financing include a cash-to-debt service ratio (1.25 to 1) and required owner compensation – usually $75,000 a year for acquisitions under $500,000 and twice that for larger deals. While not all lenders follow SBA guidelines, they are a useful national baseline for looking at your value.
The company may well be worth what you think it is, but finding a lender to finance it is a different problem. Understanding a lender’s impression of value before starting sale negotiations can save you considerable time and negotiation down the road.
