Most Private Business Owners Don’t Know What Their Company is Worth – How is That?

Private business founders, owners and management are usually effective business operators and builders who have to focus on the near-term and the bottom line. They do not typically know how their company might be realistically valued today. Rather than growing the business or planning an exit without a “dashboard” around true company value, business owners should routinely conduct a “what if we sold” analysis to determine current value and the ways that company value might be improved in the short and/or long term. The starting point is educating yourself about business value drivers, including both external market and internal company factors.

1. Value is in the Eye of the Buyer (or the IRS). It’s not as simple as applying an EBITDA multiple you’ve heard about for other sales of similar businesses. A real buyer will usually set your multiple (within some range applicable to your industry) based not just on your EBITDA and company size, but also intangible business value factors like your talent, customer makeup and traction, back-office systems, technologies and intellectual property, and even your culture (both internal team culture and external customer-facing reputation or “brand” in your market). These factors can give you a lower or higher multiple so improving them can have an exponential impact on value at any EBITDA level. And the purpose of determining business value will also impact the result – if you’re doing estate or tax planning, you will want a low value, and if you’re positioning the business for an exit soon or within a few years, you’ll of course want a high value.

2. Value Usually Depends on the Type of Buyer. If a business is sold or transferred to insiders such as family members or key management, the price and terms will have to be affordable to the insider buyers. If you’re selling to a strategic buyer, the synergies and cost-savings they can gain may justify a premium price. And if you’re selling to a private equity buyer, they will not only typically use an EBITDA multiple methodology, but also consider their financing needs (e.g., analyze their debt versus equity financing, including future debt payments, in an “LBO” model). And, if your business is an “add-on” to another business a private equity buyer already owns in their portfolio, like a strategic buyer, they may also consider the extent to which the price will result in an “accretive” or “dilutive” transaction (depending on how your financial profile benchmarks (e.g., your margins and EBITDA to revenue) with their other companies).

3. Value Is Not What You Get to Take Home. Even after a seller and buyer agree on a business value, the buyer will often require deducts for things like insufficient working capital, near-term capital expenditures and items that don’t at first seem like company “debt” to be paid off or assumed (e.g., deferred revenue and capitalized lease obligations). What’s more, the value or pro-forma “price” will always depend on the terms. An all-cash deal at a lower price may be better than a cash, buyer stock or note, and/or an earn out at a higher valuation. To avoid an ambush at the finish line, a seller should not usually name a price, but give the buyer the first shot at the valuation, adjustments and any non-cash or deferred deal consideration. And perhaps most important (given the dollars at stake), the structure of the sale can dramatically impact the income taxes the seller owners will have to pay from the sales proceeds. All to say, valuation depends on all of these factors, so each of them should be reviewed and negotiated before agreeing on any general business value.

4. Value Will Be Impacted by Founder Value and Company Readiness. Similar to the intangible value drivers that impact an EBITDA multiple, a company may have more value if it is not overly dependent on its founder and the founder and buyer can agree on what the founder’s role and continued participation will be after a sale. And the business needs to be positioned for a sale, including consideration of things like the impact of a sale on company management, employees and customer and supplier relationships. Exit planning is all about a seller positioning the founder and the business for a sale at a premium price, and steps to do this should be taken before discussing value with a prospective buyer. Or, at least, the founder and owners should get smart about all of the moving parts within valuation before engaging in buyer discussions.

5. Value Deserves an Honest Deep Dive. Sellers need to be willing to honestly determine value based on all of the above factors and to do the work to determine value for themselves before entertaining offers to sell or planning the transfer the business. The process may warrant or require some independent support from an accounting firm, broker or investment bank. Taking value for granted or simply relying on the industry rumor mill or the number the founder “needs” will not put the company in the strongest position to respond to buyer term sheets or proposals. And even if an ownership transfer or sale is not planned in the near term, understanding the business’ value now will allow the founder and company management to take steps to improve value in addition to simply driving the bottom line.

Take-Aways. Most owners don’t know what their business is “worth” for several simple reasons. First, the business may have different values depending on the circumstances, the buyer and the terms of a deal. Second, the owners may be relying on external or similar-company-transaction “country club” talk rather than educating themselves about how buyers actually value individual companies. Third, even if the seller has a decent grasp of the business’ gross value based purely on their financials, their assumed “pro-forma” value may be high or low depending on the intangible company factors that drive multiples (intangible assets and readiness). What’s more, the owners’ true equity value or any hoped-for “number” should be determined on an all-cash (purchase price), cash-free/debt-free (assuming the seller keeps the company cash and pays off company debt, considering any required normal working capital that needs to be left in the business) and after-tax basis. With this deeper valuation, price and terms dive done, the seller will be in a much stronger position to improve company value and eventually negotiate a good price and terms.

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