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Leave no money on the table

What a difference a year makes! Remember how you felt this time last year? Unemployment was at record highs, banks seemed reluctant to loan money and a new health care bill was making small business owners feel sick! Fast-forward a year and our clients, as well as our businesses, have weathered the storm. There are still clouds on the horizon and challenges ahead, but they don’t seem as ominous as they did. What are we to make of the current business climate? 

What is on the horizon? 

In the next 12 to 18 months, we believe activity will increase in the merger and acquisition markets. The climate appears to be ripe for businesses that have strengthened their balance sheet, maintained their profitability, and streamlined their operations to capitalize on available cash and credit. There are literally trillions of dollars, earning very little interest, available to be deployed in the capital markets. The word is out about the favorable business climate in Texas and, more specifically, Houston. Many of my clients have received calls from companies looking to enter the Houston market by buying an existing enterprise. 

Making the decision

What if you were to get a call asking your interest in selling your business? How would you react? 

You have built a solid organization with a good management team. You have good customer delivery processes and information systems that let you know how your business is performing at all times. You are constantly looking for ways to reduce waste and provide quality customer services. You have diversified your customer base so that no one customer can hurt your business by leaving your company.

Do you know the value of your business? After you do the math, is it enough for you and your family to live on when you retire? Are you ready to give up control of your business and become an employee of the new owners? Have the last two years been your best, or are you selling your business after the worst performing years and therefore not in a position to get top dollar? These are questions to consider before you start down the path of selling your business.

Do the prep work for “Just in Case”

If you have not already received a call to sell your business, you may in the near future. Make sure to do preliminary work before you go down that path.

  •  Design your business to be attractive to a buyer. Your company is more valuable with a diversified client portfolio and good, up-to-date information systems. Also, the more the business is dependent on you, the owner, the less value it has to a buyer.
  • Meet with a financial planner to see how much money you need to retire. Whether you sell your business or not, you need to know that information.
  • Consider doing a  sell-side due diligence project on your business. This will help determine if you are ready to go through the due diligence process a buyer will require.
  • Consider having a valuation done on your business to see what a professional that specializes in valuing businesses thinks your business is worth.
  • Finally, when you go through the exercise of selling your business, make sure you get the full value of your business at closing.
  • Determine the value of your business

Listing all of the factors that determine the value of a business is too expansive for this or any one article. There have been many books written on how a company is valued and Certified Valuation Analysts spend their careers determining the value of businesses. 

For our means, calculate the value of your business with this formula: the Market Value of Equity (VE) equals the Value of Assets (VA) less the Value of Debt (VD) (VE=VA-VD). Thus the cash (or other value) to the shareholders would be equal to the value of the assets less the debt the company has at the time of sale. 

How do you determine (VA), the value of assets? In most cases, the value of assets is determined to be the cash flow or Earnings Before Interest Tax Depreciation and Amortization (EBITDA) of a company times a certain multiple. The multiple is most often determined by the market, and is a negotiating point between the buyer and seller. Recently, multiples have hovered between three and five times, depending on the industry. In the money madness days of 2005 to 2007 multiples rose as high as eight to nine times for some companies. 

There are many factors that go into the multiple used in the sale of your business. Currently, venture capitalists are saying the most significant factor is the availability of capital. Looking back to 2005 to 2007 there was a lot of capital chasing few deals and could support the theory that availability of capital does drive multiples up. A good conservative rule of thumb for valuing your business is a multiple of 3.5 times adjusted EBITDA. Keep in mind, this does not take into consideration the value of any real estate or intangible assets such as patents or trademarks. 

Is it a good deal?

You have made the decision to entertain an offer for your business. After spending the last month or more answering questions, producing documents, and negotiating your company’s value, you have arrived at VE (value of equity). Let’s assume the VE is $2,000,000. The offer comes to your desk and is half in cash, one quarter in a note receivable and one quarter in stock in the new company. Is this a good deal? It may or may not be. My recommendation to clients is just as with any other note receivable or any other stock in your portfolio: there is no guarantee you will ultimately receive additional cash after closing, therefore make sure the amount of cash is sufficient for your needs. 

In closing

The saying, “timing is everything,” is certainly true when it comes to selling your business. Only you know when you are ready to step down, or when you want to sell to get the maximum value from your business. 

For now, until you get that call or feel the urge to do more fishing, give your exit strategy some thought. Pledge to take at least one step toward planning your exit strategy in 2011. You may want to do something that will make your company more valuable or you get your personal financial plan together so you know what it will take for you to retire when you sell your business. 

PKF Texas has team members on hand who can assist with sell-side due diligence, information system processes, valuations and other resources. We have Certified Valuation Analysts on staff.

Like Stephen Covey says, “The plan is nothing, planning is everything.” 

Byron Hebert, CPA, CTP, is a director at PKF Texas and practice leader for the Entrepreneurial Advisory Services group. PKF Texas can provide assistance to companies looking to implement the techniques detailed in this issue.