What Is a Business Worth?
Many courts and the Internal Revenue Service have defined fair market value as: “The amount at which property would exchange between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of relevant facts.” You may have to read this several times to get the gist and depth of this definition.
The problem with this definition is that the conditions cited rarely exist in the real world of selling or buying a business. For example, the definition states that the sale of the business cannot be conducted under any duress, and neither the buyer nor the seller can be pushed into the transaction. Such factors as emotion and sentimental value cannot be a part of the sale. Surprisingly, under this definition, no actual sale or purchase has to take place to establish fair market value. That’s probably because one could never take place using the definition.
So what does make up the value of a privately-held business? A business consists of tangible and intangible assets. The tangible assets are the most visible and the ones on which buyers too often base a judgment on the value of a business. Factors of value, fixtures, equipment and leasehold improvements are often valued first by the buyer. Well maintained equipment and attractive interior surroundings are the first things a buyer sees when visiting a business for sale. Make no mistake, regardless of what prospective buyers may say, the emotional impact of a physically well-maintained business can be a very positive factor. In addition, it is much easier to finance tangible assets than intangible ones.
However, buyers have to consider what is really behind those well-maintained tangible assets. There are many businesses, especially today, in which physical assets play a very small part in the success of the business. These intangible factors include: the business’ reputation with its customer or client base, and within its industry; mailing lists and customer/client lists; quality of product or service; reputation with its vendors and suppliers; strength of the business’ technology and other systems; plus many other factors that can add a lot more value to the price of the business than can shiny equipment.
Although the intangible assets listed above cannot be seen, they are certainly an important part of the business – and purchase price. Businesses that don’t need expensive fixtures and equipment can, in many cases, be expanded more quickly and inexpensively because they do not require cash-intensive equipment purchases. Buyers, to their own detriment, do not want to pay the same price for equivalent cash flow for businesses that do not have lots of equipment. They want to buy tangible assets.
Business brokers and intermediaries know how to point out to prospective buyers the advantages of businesses that may not require lots of equipment but have those all-important intangible assets that create steady cash flow. Business owners who have a service or other type of business that does not rely on the heavy use of tangible assets and are considering selling, should talk to their professional business broker/intermediary who can point out the pluses and the hidden assets of the business.
What Is a Business Worth?
Many courts and the Internal Revenue Service have defined fair market value as: “The amount at which property would exchange between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of relevant facts.” You may have to read this several times to get the gist and depth of this definition.
The problem with this definition is that the conditions cited rarely exist in the real world of selling or buying a business. For example, the definition states that the sale of the business cannot be conducted under any duress, and neither the buyer nor the seller can be pushed into the transaction. Such factors as emotion and sentimental value cannot be a part of the sale. Surprisingly, under this definition, no actual sale or purchase has to take place to establish fair market value. That’s probably because one could never take place using the definition.
So what does make up the value of a privately-held business? A business consists of tangible and intangible assets. The tangible assets are the most visible and the ones on which buyers too often base a judgment on the value of a business. Factors of value, fixtures, equipment and leasehold improvements are often valued first by the buyer. Well maintained equipment and attractive interior surroundings are the first things a buyer sees when visiting a business for sale. Make no mistake, regardless of what prospective buyers may say, the emotional impact of a physically well-maintained business can be a very positive factor. In addition, it is much easier to finance tangible assets than intangible ones.
However, buyers have to consider what is really behind those well-maintained tangible assets. There are many businesses, especially today, in which physical assets play a very small part in the success of the business. These intangible factors include: the business’ reputation with its customer or client base, and within its industry; mailing lists and customer/client lists; quality of product or service; reputation with its vendors and suppliers; strength of the business’ technology and other systems; plus many other factors that can add a lot more value to the price of the business than can shiny equipment.
Although the intangible assets listed above cannot be seen, they are certainly an important part of the business – and purchase price. Businesses that don’t need expensive fixtures and equipment can, in many cases, be expanded more quickly and inexpensively because they do not require cash-intensive equipment purchases. Buyers, to their own detriment, do not want to pay the same price for equivalent cash flow for businesses that do not have lots of equipment. They want to buy tangible assets.
Business brokers and intermediaries know how to point out to prospective buyers the advantages of businesses that may not require lots of equipment but have those all-important intangible assets that create steady cash flow. Business owners who have a service or other type of business that does not rely on the heavy use of tangible assets and are considering selling, should talk to their professional business broker/intermediary who can point out the pluses and the hidden assets of the business.
What Is a Business Worth?
Many courts and the Internal Revenue Service have defined fair market value as: “The amount at which property would exchange between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of relevant facts.” You may have to read this several times to get the gist and depth of this definition.
The problem with this definition is that the conditions cited rarely exist in the real world of selling or buying a business. For example, the definition states that the sale of the business cannot be conducted under any duress, and neither the buyer nor the seller can be pushed into the transaction. Such factors as emotion and sentimental value cannot be a part of the sale. Surprisingly, under this definition, no actual sale or purchase has to take place to establish fair market value. That’s probably because one could never take place using the definition.
So what does make up the value of a privately-held business? A business consists of tangible and intangible assets. The tangible assets are the most visible and the ones on which buyers too often base a judgment on the value of a business. Factors of value, fixtures, equipment and leasehold improvements are often valued first by the buyer. Well maintained equipment and attractive interior surroundings are the first things a buyer sees when visiting a business for sale. Make no mistake, regardless of what prospective buyers may say, the emotional impact of a physically well-maintained business can be a very positive factor. In addition, it is much easier to finance tangible assets than intangible ones.
However, buyers have to consider what is really behind those well-maintained tangible assets. There are many businesses, especially today, in which physical assets play a very small part in the success of the business. These intangible factors include: the business’ reputation with its customer or client base, and within its industry; mailing lists and customer/client lists; quality of product or service; reputation with its vendors and suppliers; strength of the business’ technology and other systems; plus many other factors that can add a lot more value to the price of the business than can shiny equipment.
Although the intangible assets listed above cannot be seen, they are certainly an important part of the business – and purchase price. Businesses that don’t need expensive fixtures and equipment can, in many cases, be expanded more quickly and inexpensively because they do not require cash-intensive equipment purchases. Buyers, to their own detriment, do not want to pay the same price for equivalent cash flow for businesses that do not have lots of equipment. They want to buy tangible assets.
Business brokers and intermediaries know how to point out to prospective buyers the advantages of businesses that may not require lots of equipment but have those all-important intangible assets that create steady cash flow. Business owners who have a service or other type of business that does not rely on the heavy use of tangible assets and are considering selling, should talk to their professional business broker/intermediary who can point out the pluses and the hidden assets of the business.
A Different Look at Valuing Your Company
Is there pricing elasticity?
What’s proprietary?
What’s the company’s competitive advantage?
Status of employment agreements and non-competes?
Post-Acquisition:
Are there cost savings after purchase?
Are there significant capital expenditures pending?
Is there synergy with the seller?
Is it perceived the integration will go smoothly?
Are there substantial cross-selling possibilities?
Will the cultures blend?
The Financials: By training and education, many business appraisers emphasize the numbers. They will look at the past, current and future numbers. They will consider all the basic financial figures such as:
• growth rate
• return on investment
• gross profit percentage
• EBITDA percentage
• industry metrics
• debt to net worth
• book value
Fundamentals: Business appraisers should also consider the company’s history, its management, products, distribution, etc. The following should also be seriously considered: multi-products, different markets, wide distribution and the quality of management.
Value Drivers: These are important business elements that are most often ignored or completely overlooked by business appraisers. However, they are very important to a potential buyer.
• product differentiation
• defensible position
• technology
• dominant market share
• well-known brand(s)
• cost advantage
• proprietary customer
Creating Value in Privately Held Companies
“As shocking as it may sound, I believe that most owners of middle market private companies do not really know the value of their company and what it takes to create greater value in their company … Oh sure, the owner tracks sales and earnings on a regular basis, but there is much more to creating company value than just sales and earnings”
Russ Robb, Editor, M&A Today
Creating value in the privately held company makes sense whether the owner is considering selling the business, plans on continuing to operate the business, or hopes to have the company remain in the family. (It is interesting to note that, of the businesses held within the family, only about 30 percent survive the second generation, 11 percent survive the third generation and only 3 percent survive the fourth generation and beyond).
Building value in a company should focus on the following six components:
- the industry
- the management
- products or services
- customers
- competitors
- comparative benchmarks
The Industry – It is difficult, if not impossible, to build value if the business is in a stagnating industry. One advantage of privately held firms is their ability to shift gears and go into a different direction. One firm, for example, that made high-volume, low-end canoes shifted to low-volume, high-end lightweight canoes and kayaks to meet new market demands. This saved the company.
The Management – Building depth in management and creating a succession plan also builds value. Key employees should have employment contracts and sign non-compete agreements. In situations where there are partners, “buy-sell” agreements should be executed. These arrangements contribute to value.
Products or Services – A single product or service does not build value. However, if additional or companion products or services can be created, especially if they are non-competitive in price with the primary product or service – then value can be created.
Customers – A broad customer base that is national or international is the key to increasing value. Localized distribution focused on one or two customers will subtract from value.
Competitors – Being a market leader adds significantly to value, as does a lack of competition.
Comparative Benchmarks – Benchmarks can be used to measure a company against its peers. The better the results, the greater the value of the company.
Three keys to adding value to a company are: building a top management team coupled with a loyal work force; strategies that are flexible and therefore can be changed in mid-stream; and surrounding the owner/CEO with top advisors and professionals.
The Value of a Business: Get to the Heart of the Matter
What is the value of your business? There are many ways to approach that question — based on complex formulas or just a good hard look at the balance sheet, but no answer based purely on numbers is going to be exactly right. Even factoring in that most popular of abstracts — goodwill — the true essence of an operation is not likely to be revealed.
To find the real value of a business, we must go to its very heart: the attitude, work habits, managerial style, customer/marketplace savvy, and community reputation of the person in charge. The business owner or manager is the final, and most cogent, indicator of business worth. Check out the following healthy signs, and then listen to the heartbeat of your own business and its leadership style:
Optimistic Attitude
Many business owners today are more pragmatic and take pride in being less of an “incurable optimist.” The owner of yesterday wasn’t afraid to follow the words of Willy Loman in Death of a Salesman: “A salesman has got to dream, boy. It comes with the territory.” A decline in optimism is an unfortunate trend. In a world driven by technology and scientific analysis, it’s easy to forget the importance of the right attitude. If business owners aren’t positive, how can they expect customers and employers to be? The owner who believes business is bad will probably not see it getting any better. Of course, there are always the real-life factors — banks that won’t lend, customers who stop buying, services that become obsolete. However, if these problems didn’t exist, there would be something else to keep the negative thinkers occupied.
How to project a positive attitude? Begin with the easiest. Sprucing up the place of business with fresh paint, newly-cleaned carpeting, well-stocked shelves, for example, will say a lot for the health of a company. Less visible, but highly important, is a positive outlook on the future of the business. Business owners should be prepared to spend what it takes to generate new business, and should take the time to explore new possibilities for long-range success. If the company currently has no mission statement or business plan, creating one will speak volumes abut owner’s enthusiasm for the future of the operation.
Healthy Managerial Style
In the modern workplace, where you can hardly see the business through the forest of “managers,” it’s good to get back to basics. Too often, owners get bogged down in busy work, or in “managing the managers.” They should occasionally take time off to work the floor, drive the delivery truck, sell the product. Owners who put themselves in the trenches are in touch with the business — and this first-hand understanding will be evident to anyone taking stock of the company’s worth.
An equally healthy approach to managing is preparing for contingencies. The owner’s style should include appropriate delegation of duties and a backup managerial plan in case of unforeseen calamity.
And finally, owners should project a general sense of well-being and energy. This may be easier said than done, but it’s important to note. Anyone taking stock of a business will draw a quick, and key, first impression from the very posture and tone of voice the owner presents.
Customer relations say a lot about the “heart” of a business. The business owner’s approach to handling customers sets the standard for everyone down the ladder. A healthy business avoids treating the customer like a number — or maybe worse, like a stranger. For example, successful big-time operations who deal with customers by telephone make it a point to ask for the proper pronunciation of a name, or request permission to use the customer’s first name. Added to basic courtesies is the sense that salespeople are happy to take the time necessary to answer questions and/or deal with problems.
Whether products and services are sold by phone or on the floor, employees should be well-versed experts on whatever they’re selling. Again, large outfits have established high standards to emulate; for instance, the outdoor equipment chain with salespeople who can not only fit hiking boots to a T (or a toe), but also know how to clean, weatherproof and care for the leather, vibram, or nylon of which the boots are made. Every hour spent training salespeople in the product pays huge dividends for the company’s long-term success.
Conspicuous Image
To foster the image of an on-going, healthy business concern, business owners need to keep their image prominent before the public. Advertising can build image at the same time it attracts business. Anything from a display ad within the yellow pages listings, to a monthly “home-baked” newsletter, to the offering of free seminars, can portray the business as more than just the sum of its products. An example of image-making at its best comes from the owner of a natural foods store in a metrowest Boston town. She not only produces her own monthly newsletter (with product information and coupons, plus general health articles), but she also sponsors evening lectures on subjects such as acupuncture, aromatherapy, women’s health, and children’s nutrition. What’s more, she offers free tours of her in-house cookie “factory” to local schools. The samples the kids take home are the best cost-per-inch ad value imaginable!
For the less adventurous, there are plenty of conservative ways to make ads pay. Every Saturday for years, the sports section of a Los Angeles newspaper carried a one-inch ad for the “Best Hamburger in Town.” No catchy phrases, no dazzling graphics, but the ad was there — and there — and there again. The consistency sold the restaurant’s product and its image and eventually, the eatery became a 10 plus chain.
Community Involvement
To further promote the business — and its owner — as a rock-solid and permanent part of the local scene, there are opportunities just waiting to be tapped. Taking an active role in the Chamber of Commerce, trade or service associations, or sponsoring worthy local events all lead to great public relations. In addition to the more traditional public donations — providing kids’ sports team uniforms, taking out ads in yearbooks — the business can band together to join walkathons, or volunteer to man the phones for public TV or radio fundraisers. Doing “good” makes the business owner and the employees feel good about themselves.
“Feeling good” is a good point at which to conclude our journey to the heart of a business. Dollars and cents will always be important in establishing value, but it’s a kind of people-sense that will give the truest reading.