Every industry has some valuation rule of thumb. My company should be worth “X times this” or “Y times that”, etc. In reality, the value that a buyer is willing to pay for your business is not based on a mathematical equation. While it can be influenced by general market conditions such as a tightening credit environment or values paid in the market for comparable businesses, it has far more to do with the inherent quality of your business than anything else. Certain attributes of your business that influence its value are as follows:
Financial Performance: Financial performance is key. No other single factor can influence the value of your business more than its ability to generate earnings (cash). With rare exception, the greater the earning power of your business, the more the business is worth.
Proprietary Nature: The identity and niche that you have created are (presumably) defensible, and for this reason, desirable from a buyer’s perspective. Thus, if your business manufactures and/or distributes products that carry a proprietary label (brand), it is more valuable than comparable businesses that lack their own identity [such as a job shop or private label manufacturer.]
Sustainability: When a prospective buyer looks at your business, they are looking to purchase a “machine” that will (and can) continue to generate the earnings that you have demonstrated. However – can your business do everything that it does now after you (and your partners) sell and presumably leave the business? Is it really sustainable?
The issue here is management. If your business is dependent upon you or possibly you and another key seller, its value is less than it would be if it were managed by a management team that can be expected to stay with the business for the long term.
A final key dynamic that influences value is synergy. If the combination of your business with another creates unique value, a buyer will be driven to pay a unique value for it – possibly even a value that exceeds the market.
Terms & Conditions
While terms and conditions vary on a case-by-case basis, the following generalities apply:
Known Problems: No buyer will buy your problems. Thus, if your business has issues or problems that relate to your stewardship of the business, the responsibility for such matters remains yours. Environmental issues are a good example. If your facility has an environment issue, you (and your partners) will be required to retain full responsibility for the problem if the business can be sold in a best case scenario. In a worst case scenario, the problem could derail the sale. In any event, your problem(s) remains your problem(s).
Price v. Terms: When a business is sold, a business owner typically expects to receive 100% of the purchase price in cash at closing. However, in reality, this situation is rare. If the transaction is indeed an “all cash” transaction, typically a portion of the purchase price is held back by the buyer as insurance for known or perceived areas of exposure. The portion held back (the “holdback”) is paid at a later time based upon case-by-case circumstances often over 1 to 2 years following the sale.
Just as typical is a transaction involving some consideration that is paid (or realized) following the sale of the business. Examples would include i.) payments relating to a covenant not-to-compete or a consulting arrangement; ii.) a seller note provided to facilitate the buyer’s acquisition of the business (often providing for payment over 3 to 5 years following closing); or possibly iii.) the use of some form of earnout arrangement that provides the seller a mechanism to receive additional proceeds (value) based upon the performance of the business after closing. And in circumstances involving a buyer that is a publicly traded company, you may be asked to accept publicly traded securities as part of the sale proceeds.
Overall, a seller’s willingness to accept, in part, some form of consideration paid (or realized) following the sale of the business will result in greater aggregate value.
The Unknown: When your business is sold, you will be expected to stand behind the business you are selling. Essentially, if a problem from the past surfaces after the business is sold, you will be expected to indemnify the buyer for the problem (through a process embodied within the definitive legal agreement).
Your involvement (and that of other key owners) in the business following its sale will vary based on many factors. At a minimum, you should expect to participate for a short period of time (60 to 120 days) simply to facilitate the new team’s transition into the business. However, if you are a key participant in day-to-day operations or possibly the one who maintains all major customer relationships, your involvement may be required far longer (possibly 1 or 2 years).
It is unrealistic to think that you can sell your business and walk away no matter how burning your desire is to retire and/or do something else. That is why the process must be planned well in advance. You willingness to stay with the business, if required, will affect the value you receive for it.
A timeframe of 120 to 180 days from preparation of company background information to closing is realistic, with the assistance of professional advisers. Shorter timeframes are possible but not typical.