January 30, 2018 //
For many clients, the time between first thinking about selling their business and walking in our door is several years. This interval can be important in maximizing your selling price, if you know how to use it well.
The first thing we need to understand when trying to value our own company is that the buyer will always set the price – that’s what the business is worth to them. Consequently, the self-valuation starts with having an understanding of how businesses are usually valued, but then moving the focus onto the value drivers that the buyer will ultimately see in the business. Our job is to effectively prepare the company by building on these value drivers before the sale.
How Businesses Are Usually Valued
An M&A professional usually approaches business valuation from three distinct angles, then uses qualitative information and market judgment to refine initial calculations into a range.
1: Value of the Company’s Assets
The cost, or asset, approach estimates the liquidation value of a company’s balance sheet assets, less liabilities. Because it does not reflect the value of the business as a going concern, it typically yields the valuation “floor”.
2: Comparable Market Activity
The market approach estimates a company’s value using transactional data from comparable deals. It has the benefit of incorporating a range of economic and intangible factors into the estimated price. But drawbacks include the difficulty of finding truly comparable, recent transactions, and – especially for private companies – the availability, comparability, and quality of data.
3: Value of Future Cash Flows
This approach includes various ways to place a present value on a company’s expected future cash flows. A range of measures may be used to express current and future income. And different calculations are employed based on the expected stability of earnings and growth. The simplest, most common calculation used to value privately owned businesses is:
Adjusted EBITDA x EBITDA Multiple
… where a company’s EBITDA is adjusted to remove discretionary or non-recurring expenses, and the multiple is a published number, widely reported by quarter, industry, and transaction size.
This is the most popular do-it-yourself method for estimating business value. But it yields an inflated number, because published multiples are almost always higher than actual multiples. The inclusion of earn-outs and other contingent payments before they are earned means that transaction values are often overstated. Non-income related balance-sheet adjustments are commonly included in the transaction value. And EBITDA is often reported without the normalizing adjustments that are part of any private company sale.
But the good news is that, though the market value of your business may be a rough estimate at this point, there are lots you can do now to maximize your eventual return.
Eight business characteristics will help you to command a premium price when the time comes. We call these the Value Drivers, and use them as a checklist for evaluating the more “qualitative” attributes of our client companies. They are:
Buyers aim to maximize profit and minimize risk. Your results-driven management team, growth strategy, and cash flows all speak to profit maximization. The other attributes boost value through minimizing the associated risks.
Now is the time to complete your own internal assessment. Where does your company already excel? Where are your biggest gaps? How can you close them?
A key factor behind high business valuations is low interest rates, which mean a low cost of debt, and plentiful funding available to buyers. For Canadian companies, exchange rates also have an impact. A lower Canadian dollar makes your business attractive to foreign buyers, increases what they are able to pay, and reduces the overseas options available for Canadian buyers.
Neither factor is easy to predict with precision. But with the luxury of time, and an informed perspective, you can wait out unfavourable periods, and take advantage of opportunities.
You want the buyer that will most highly value on your business. Broadly, buyers may be strategic or financial. The two types will differ in terms of their investment horizons, financial experience, risk appetites, and specific strengths they are looking for. Among strategic buyers, there is often significant variance in how they value your company, based on how it will contribute to their overall operation.
Nobody knows your industry as well as you. One way you can use this interim period constructively is to look out for who might gain the greatest benefits from your business, and why. Can a key customer secure a strategically crucial input? Is disruption making your industry suddenly attractive to outside players? Are there mounting pressures for consolidation? This intelligence will help your M&A advisor act most effectively on your behalf.
So even though you may not yet be ready to sell, there is plenty to be done to position yourself for success.