You may have heard the expression “anything is worth exactly the amount that one highest bidder is willing to pay.” While that anecdote is not particularly useful for planning purposes (should I sell? Is my business worth enough to justify my decision to sell? Is the timing right?), it does help justify the vague reactions to the question regarding value that you will hear. “While valuation is calculated, price is negotiated.” (The Intelligent Exit, by Mark Carmichael) That said, there are some generally accepted guiding principles and there are some levers at your disposal to help reduce the risk that a buyer may see with an acquisition. Reducing buyers’ perceived risk will increase value.
Do you need an appraiser or valuation services company? For the purposes of selling, no you do not. However, if you have no idea how much your business is worth, and you are trying to decide when the time might be right to start soliciting offers, a good start might be a third-party valuation. Think of that assessment as a rough Go/NO Go tool for you, but not as an actual representation of what a buyer might pay. It could be a lot less or a lot more than what the valuation firm tells you your company is worth on paper.
Generally speaking, private businesses are not valued by a valuation firm or appraiser, as these are for purposes other than determining the purchase value. Business being acquired are valued by potential acquirers as a multiple of EBITDA. EBITDA is defined as earnings before interest, taxes, depreciation and amortization. This method is used to level the playing field; “EBITDA allows investors to consider the consequences of operating decisions while ignoring the impact of non-operating decisions such as tax rates, interest rates, and accounting choices.” (The Intelligent Exit, by Mark Carmihael) The reported EBITDA to the IRS may be artificially low in order to reduce your taxes. Therefore, acquirers take into account “adjusted” and “restated” EBITDA to allow for personal expenses, other perks, litigation costs, repairs and maintenance costs that are not routine, inflated salaries, real estate costs, and non-recurring or one-time expenses that may have occurred in the recent past. The result is an EBITDA number that the acquirers believe is a reasonable representation of what they could expect from the business on a go-forward basis, with nothing else changing.
Acquirers then assign a multiple of that adjusted, restated EBITDA number to serve as an indication of how comfortable they feel about downside risks to the business and how bullish they are about the future prospects to grow that EBITDA number. Generally speaking, the smaller the business, the higher the perceived risk. There is more likely to be year-to-year swings impacting annual profits. So, a small company, with EBITDA numbers of less than, say $2 million, might have a multiple of 3-7 times earnings. What drives the valuation to be on the higher end of that scale? Industry (some industries are riding a rising tide of growth), customer relationships (customer concentration or bargaining power would be a negative; customer loyalty and recurring revenue are positive drivers); highly organized businesses, with strong leadership teams, processes, systems might also be on the higher end of that 3 to 7 scale.
Organizations with much higher levels of EBITDA (say $10 million+), in favorable industries (Software, for example), with high recurring revenue from a wide array of customers, and plenty of obvious runway for growth, might be valued by potential acquirers at more than 15 times EBITDA. In fact, they might even be valued at a multiple of revenue, not earnings!
Determining the value of your business is a critical step in preparing for a sale, and understanding how this value may differ from the actual price a buyer is willing to pay is equally important. the amount a buyer is willing to pay may differ for several reasons:
a. Negotiation Dynamics
The buyer’s offer is often shaped by the negotiation process, which can include:
- Strategic Value: A buyer may pay more if they see strong strategic value (e.g., synergies, access to new markets, or complementary products).
- Deal Structure: Payment terms, earn-outs, contingencies, or financing terms can all influence the final deal price.
- Buyer’s Appetite: The urgency or motivation of the buyer (e.g., a financial buyer vs. a strategic buyer) can drive a premium or discount on the valuation.
b. Market Conditions
Economic and market conditions can affect a buyer’s willingness to pay. In a buyer’s market, where there are more sellers than buyers, offers may come in lower than the valuation. Conversely, in a seller’s market, the right buyer may offer a premium.
c. Due Diligence Adjustments
During the due diligence process, buyers may uncover issues or risks not previously considered in the valuation (e.g., hidden liabilities, contract risks, or operational inefficiencies). These findings can lead to price adjustments, often in the form of lower offers or the inclusion of contingencies.
d. Buyer’s Risk Perception
A buyer’s perception of risk can impact the final price. If the buyer views the business as having higher risk (e.g., due to dependency on key customers, low bargaining power with key supplier, poor market positioning, an untested management team, or intellectual property risks – low or no legal protection for the company’s intellectual property, poor administrative management such as corporate documentation, legal documents, or even a lack of process statements; personal skeletons in the closet tied to the business), they may offer a lower price – or walk away.
e. Seller’s Motivation
The seller’s urgency to sell can influence the price. If a seller is highly motivated (e.g., due to retirement, financial difficulties, or personal reasons), they may be willing to accept a lower price to expedite the sale.
2.There are Several Known Factors that Affect Business Value
A business’s value can be influenced by numerous qualitative and quantitative factors, including:
- Financial Performance: The consistency and stability of revenue, profit margins, and cash flow.
- Growth Potential: The scalability and expansion opportunities for the business.
- Market Position: Competitive advantages, brand strength, and customer base.
- Industry Trends: Market demand, regulatory environment, and economic conditions.
- Management Team: The strength and depth of the leadership team. How ready are you to enable key members of the management team to run the business in your absence? Since a key diligence question will be “how reliant is the business on you for its long-term success,” you will need to ensure that you have a reliable team in place. If you are hit by the proverbial bus, the business needs to continue thriving without missing a beat. If this is not the case today, it should become a priority to rectify.
You should also consider management retention. How loyal and long-term are your most important employees. Excessive turnover speaks poorly of your culture, confidence in you as a leader or the perceptions of long-term growth and prosperity of the business.