Thought Leadership on Ownership Transition presented by Prairie Capital Advisors, Inc.
There are several paths a business owner can take when it comes to transitioning ownership.
For example, an owner may sell to a strategic buyer, to a financial buyer or to the company’s management team. The owner may also decide that a full or partial sale is several years in the future, but is interested in exploring gift and estate tax planning strategies or buying out another owner. When contemplating any transaction, obtaining a business valuation is critical and will give the owner a competitive edge. By going through the valuation process, an owner will learn which drivers that positively and negatively impact value. Armed with a valuation, an owner can make intelligent business decisions.
Key Value Drivers
Most business owners understand that private businesses are typically priced as a multiple of earnings before interest, taxes, depreciation and amortization (EBITDA). Companies with higher growth potential and greater free cash flow typically command higher multiples of EBITDA. Generally, multiples increase as the company’s size increases.
In addition to size, there are internal and external factors that affect value. Internal drivers include the company’s margins, management team depth and experience, customer concentration, business plans and growth strategies. External drivers include market conditions, lending conditions, industry specific factors and government regulations. A business owner typically has little to no control over the market conditions that affect value, but does have control over the internal value drivers.
The Valuation Process
It is important for business owners to understand the valuation process. The first step in process is scoping the engagement. This involves identifying the goals and objectives of the business owner, outlining the valuation process and determining the standard of value to be employed in the valuation. A few of the various standards of value are listed below, with the first three being most common:
- Fair Market Value
- Fair Value
- Investment Value
- Use Value
- Book Value
The standard of value applied in the valuation is specific to the goals and objectives of the business owner and should be discussed at the outset of the engagement process, prior to conducting any analysis. In certain circumstances, such as selling to an ESOP or for gift and estate tax reporting, the standard of value is mandated by law. In those instances, the appropriate standard of value is fair market value, which is the price between a willing buyer and seller, with each having reasonable knowledge of all relevant facts.
Once the scope of the engagement is determined, the second step of the process is to perform initial due diligence; i.e., collecting financial data, background and history of the enterprise, budgets, customer lists, business plans and other important documents.
Step three is a continuation of the second step. During step three, the valuator has detailed discussions with the business owner and explores the inner workings of the business. This step usually includes an on‐site due diligence meeting with key personnel. After the valuator completes step three, the valuation models are constructed (step 4). In developing the valuation models, the valuator typically considers various valuation approaches deemed appropriate by the circumstances.
Step five entails reviewing preliminary schedules with the client. Depending assignment and the scope of the engagement, the preliminary schedules may or may not communicate all of the assumptions and value conclusions. This may be to protect independence, but in all cases this serves as a quality‐control measure.
Step six is when the valuator prepares the final report and deliverables for the client.
Step seven is the formal presentation to the client, which may include an oral presentation of the report and detailed explanation of the conclusions reached.
It is never too early to start planning the transition of a business. Ideally, business owners should discuss their goals and options with their financial advisors years well in advance of any transaction because of the many complex issues that arise as a result of ownership transition. Finally, business owners should understand the key value drivers and so that they can implement a strategy to meet their long-term goals.
October 6, 2014
BizBuySell.com's Third Quarter 2014 Insight Report shows transaction levels still on pace for record-breaking year, sellers now receiving a higher percentage of asking price and improved cash flow multiples
San Francisco, CA - October 6, 2014 -- BizBuySell.com, the Internet's largest business-for-sale marketplace, reported today that third-quarter small business transactions remained at historically high levels. The full results are included in BizBuySell.com's Q3 2014 Insight Report, which aggregates statistics from business-for-sale transactions reported by participating business brokers nationwide.
A total of 1,987 closed transactions were reported in the third quarter this year, representing both a 17.9 percent increase from last year and the highest number of small business sales recorded in a third quarter since BizBuySell began tracking data in 2007. In fact, this quarter's numbers slipped just 2.1 percent from the second quarter of 2014, which remains the most active quarter for small business sales since before the recession. It also keeps 2014 on pace to record the highest number of small business transactions since the report's inception.
"After seeing a return to robust transaction activity during 2013, it's good to see that we have not plateaued and both buyers and sellers are still eager to make deals happen," said Bob House, Group GM of BizBuySell.com and BizQuest.com. "There remains a strong supply of quality small businesses on the market. As the economy and financing options continue to improve, buyers remain very interested in acquiring small businesses."
Financials Show Market Shift Beginning to Benefit Sellers
While the post-recession market has generally favored buyers, a shift appears underway, with sellers now receiving higher sales prices. The median sale price for businesses sold in the third quarter rose 5 percent compared to last year, increasing from $180,000 to $189,000. Meanwhile, the median asking price remained virtually unchanged, rising just 0.5 percent from $199,000 to an even $200,000. This means sellers in the third quarter were able to receive roughly 95 percent of their asking price, the highest percentage we've seen since the recession hit in mid-2008. Active sellers appear to be taking notice of the market change as the median asking price of businesses listed on BizBuySell.com also increased 4.3 percent in Q3.
Sellers' increased negotiation power is likely a result of stronger small business financials. Both the median revenue and median cash flow of businesses have risen each quarter of 2014, and were up 1 percent and 2 percent respectively in the third quarter.
But perhaps even more telling is how much sellers are receiving in relation to their revenue and cash flow. The average revenue multiple grew nearly 6 percent this quarter compared to last year, now up to .62. At the same time, the average cash flow multiple jumped even higher, up nearly 9 percent to 2.38.
While buyers are still receiving good value for their investments, rising multiples show that sellers are now successfully translating their financial growth into higher sales prices. It's a sentiment we also saw sellers express themselves in BizBuySell's recently released Buyer & Seller Confidence Survey. The study revealed sellers are more confident they will receive an acceptable sales price this year than they were last year. In fact, 21.2 percent of sellers said they were "very confident" they could sell at an acceptable price, a 20 percent increase from those who felt the same in the 2013 survey. Nearly 47 percent of those that were more confident this year credited improving business financials as the primary reason, a feeling that is reflected in the rising revenue and cash flow data this quarter.
"After hearing sellers voice their confidence in the survey and now seeing this transaction data support their claim, it certainly appears some momentum is shifting back towards a balanced market," House said. "The supply of small businesses being listed is still growing and we believe it will continue to be a great time for both buyers and sellers to enter the business-for-sale market."
Even with increased seller confidence, buyers also remain generally confident with 78.6 percent believing they can buy at an acceptable price, according to the same survey. Improving lending conditions and the overall growth of the economy are helping buyers meet the higher demands of sellers. Buyers are also benefiting from the increasing number of sellers willing to offer seller financing in order to push deals through. In the BizBuySell Confidence Survey, nearly 30 percent more sellers planned to take on part of the financial burden through seller financing than planned to in 2013.
More Manufacturing, Service, & Restaurant Businesses on Market
In addition to an increasing number of closed sales in Q3, there were also a growing number of businesses listed for sale. Total listings were up 2.2 percent from the same time last year, with the most notable growth in manufacturing businesses (up 4.1 percent), service-industry businesses (up 3.9 percent) and restaurants (up 3.5 percent).
These sectors also saw an increase in the number of closed transactions. Service-related businesses led the way with a 17 percent increase while manufacturing was up 16.2 percent and restaurants up 13.3 percent compared to last year. The overall mix of sold businesses remained consistent with last quarter.
High Transaction Activity Likely To Continue Through End of 2014, Into 2015
As mentioned above, 2014 remains on pace to record the highest number of closed transactions reported since the BizBuySell Insight Report inception in 2007. There is increasing supply and demand in the market, and if this continues as expected, both buyers and sellers will be confident enough to enter the market. In fact, in our recent Buyer & Seller Confidence Survey, 95 percent of buyers and 75 percent of sellers hope to close a deal in the next 1-2 years.
"It's an exciting time in the business-for-sale market as conditions continue improving and that growth is being reflected in both the financial and total transaction data of small businesses," House added. "We're excited to see what 2015 brings to the market."
By, Kevin Freeman, CBI, Managing Partner, Stony Hill Business Brokers
As an M&A Intermediary and Business Broker, I speak to hundreds of business owners every year, and it never ceases to amaze me that 80% of them have absolutely no idea what their business is worth nor any concept of their exit plan.
“Failing to plan is planning to fail…”
Business Owners spend incredible amounts of time, resources and finances growing their business, however, in many cases have no focus on the end goal of the company. They do not plan for an eventual exit and therefore leave hundreds of thousands of dollars or more on the table because they simply did not have an exit strategy. That strategy can change over time, as life throws curveballs and personal factors come into play.
“Your company is worth what someone or another company is willing to pay for it…”
A solid exit plan begins with a business valuation. As I said, I am amazed on a daily basis how many business owners have no clue what their company is worth. They may have a few preconceived notions about multiples of revenue or profits based on another deal they heard about, but no real idea on value.
Ultimately, the final “value” of a company is what someone or another company is willing to pay for it. Understanding that value is a key element of successful business growth. Factors that we look at in determining a company’s value are: Industry trends, Industry Comps, Revenue, Cash Flow (net profit), EBITDA (earnings before interest, taxes, depreciation and amortization), customer concentration, contracts and employees amongst other things. We determine what a business will sell for and why, NOT what it is worth to the owner…this is crucial data that will help in all phases of business growth.
Contact Stony Hill Business Brokers today to begin your exit plan with a Business Valuation.
When selling your business, you have two options:
- Sell your business yourself
- Hire a business broker
While it’s possible to successfully sell your business on your own, hiring a business broker often guarantees a quick and painless sale.
Unlike many small business owners, brokers have years of experience in selling small businesses. They know what works and what doesn’t, making them extremely helpful when handling tasks such as business valuation, advertising or marketing, prospect interviews, negotiation, due diligence, and other critical aspects of the sale.
Hiring a broker also allows you, the owner, to focus on running the business and increasing its value while the broker handles the details of the complex transaction.
If and when you decide to hire a broker, make sure you properly vet your options, as having a quality broker can mean the different between a successful business exit and a long and costly sale.
Whether you are choosing a new broker or deciding if your current broker is right for your upcoming sale, here are six key areas you should address:
Should you sell your business? is a big question. It can be up there with Is she the one? or Should we have one more baby? Maybe it’s not that big, but it can certainly change the direction of your life.
The subject is too complex to be covered briefly, but this article will provide an overview of the issues a business owner needs to address when considering a sale. In particular, we will focus on how to assemble a strong team to guarantee a totally smooth process. (I’m kidding – there is no such thing as a totally smooth business sale. However, there are ways to improve the odds of a positive outcome.)
We will address the following topics, with particular emphasis on question No. 4, since working with the right people can go a long way toward successfully handling the rest:
1. Why Sell?
2. For How Much?
3. Who Is the Buyer?
4. Who Will Help You?
5. What Should You Do With the Proceeds?
6. What Do You Want to Do With the Rest of Your Life?
Statistics show that 50 percent of new businesses fail within the first year. That number jumps to as high as 95 percent within five years. Knowing this, if you’re currently running a successful business and raking in profits, it has tremendous value. And even though things might be going quite well, this is exactly why selling your business makes sense - even when things are good.
Buyers though are sometimes stumped as to why anyone would sell when business is going smoothly. It’s often viewed as suspicious and even too good to be true. Most potential buyers might agree that there aren’t enough good businesses around worthy of investing in. But when a good one does present itself, countless questions arise to the validity of that sale arise.
As a buyer, it’s important to look a littler deeper into the common reasons why people are willing to hand over a good business that’s performing well. Divorce, health issues, a family death, retirement and even sheer boredom are all valid and ordinary reasons to put a business up for sale. The latter is probably the more common than expected, as entrepreneurs tend to be adventurous, always seeking a new and exciting opportunity. For a person who has never bought or even owned a business, it can be difficult to grasp the concept of moving on to something new, especially when business is profitable.
It’s important for buyers to focus on more pressing matters than why a business is being sold. Revenues, profits, growth potential and ease of transition all weigh more heavily than that one factor. As long as records and documentation confirm that the business is in fact in good health, everything else is more likely to fall into place.
Are you thinking about buying or selling a business? Take the first steps by downloading one or both of our free reports: 7 Questions to Ask Before Buying a Business and 7 Questions to Ask Before Selling Your Business.
I first met Kevin Freeman in 2008. I owned 2 small businesses and I was interested in purchasing a third. I was looking for an existing business that already had a strong support team in place and also had room to grow. Kevin found a business for sale that met all of my requirements, Westway Electric Supply. We went ahead with the purchase and Kevin was instrumental throughout the process and even helped me locate a bank willing to finance the deal. The process went very smoothly.
After a few years I was able to grow the business through a new website, www.WestwayElectricSupply.com, and I no longer had time to manage my other two business. I went back to Kevin and asked him if he could sell them quickly. Kevin went to work and soon had a number of potential buyers for each business. He helped me sort through the offers and determine who were legitimate buyers. He continued to advise me throughout the selling process and we got both businesses sold within our target price range and before our target date. I will definitely continue to use Kevin's services in my future dealings.
President, Westway Electric Supply
We are pleased to announce that our Managing Partner, Kevin Freeman, was featured in Smart CEO magazine. Please see the article below and as always please feel free to reach out to Stony Hill for all your exit planning and business acquisition needs.http://viewer.zmags.com/publication/9d7e8af8?page=16&nocache=1358367227031#/9d7e8af8/16
When you are ready to sell a business what type of assistance will you need to do so successfully? If the thought of selling a business on your own seems like a good idea, you may want to rethink that approach. In theory, taking it upon yourself to wheel-and-deal a business sale can seem like an invaluable learning opportunity. However, in reality, a DIY effort is better left to home improvement projects — not the prospect of selling a company.
Here is what you risk losing when you choose to sell business without professional help.
Figuring out how to sell a business can be a time-consuming endeavor. During the daily operations of successfully running and maintaining a business, is there enough free time for you to act as your own selling agent? Probably not. Professional help can drum up buyer prospects while you keep the company up and running.
Time is not the only thing you need to keep a business afloat when considering selling it. You need focus, too. Business services and costs still need your full attention, especially during a business sale. A large part of successfully selling a business involves scrutinizing the numeric bottom lines. A professional business broker company can help with those final details while you manage the finer details of your daily costs.
Information leaks of a potential business sale can send current and prospective clients and vendors scrambling for a protective exit zone. Hiring professionals to help sell your business helps to keep a lid on pending transactions and keep your clientele intact. Without customers and suppliers, your business could lose the fortitude it needs to appear an attractive package for potential buyers.
Need more pointers on how to get started with selling your business? Download our free guide now!
So, you are going to realize some or all of your investment in your business… now what?
Rarely in life do you come to a true, unmistakable fork in the road. Marriage and parenthood come to mind. A business exit can be similarly monumental.
Hopefully you go through the exit process with a surplus of good advice. Business brokers, attorneys, accountants, and bankers can all be sources of guidance (ideally your various advisors work in concert to provide a cohesive and coordinated framework of advice). As Wealth Managers, our role is to help coordinate the big picture that exists somewhat apart from the transaction itself. In particular we help answer two key questions:
1) How much money do you need to meet your goals?
2) What is the best way to position your assets to maximize your chances of success?
Just as your advisors should coordinate their input during the business exit or recap, an ideal wealth management process involves ongoing collaboration between multiple providers such as your CPA, estate attorney, insurance broker, and others. Our task as Wealth Managers is to help organize the many disparate but related areas of your financial life (some of which may have been neglected while you were focusing on the business).
Some important areas of consideration:
1) Estate planning - The estate tax rules have been in flux, and the sale of a business means your personal situation may have changed dramatically. It is time to revisit your trust and estate documents. The sooner you begin your planning ahead of the exit, the more options you may have in terms of keeping assets in the family.
2) Insurance coverage - With more wealth comes more liability exposure. We recommend a full review of all forms of insurance in order to reveal potential areas of exposure, and to maximize your level of coverage per dollar spent.
3) Qualified and non-qualified retirement plans – Evaluate rollover and distribution options with an eye toward tax efficiency.
4) Investment of sale proceeds - Given low interest rates, high government debt, and varied geopolitical risks, this is a difficult environment for investing. We recommend hyper-diversification and a thorough examination of issues such as costs, tax impact, and cash flow timing.
If you are realizing a successful exit from a business chances are you understand the importance of planning and preparation. Apply those concepts to your wealth management process to increase your chances of long-term success.
By Patrick M. Foley, CFP®, QPFC
Robert W. Baird & Co.