Business Valuation - Critical for Pre-Sale Planning

An independent professional business valuation is a critical element of pre-sale planning for business owners.  

Various studies indicate that between 60% and 75% of business owners will exit their businesses within the coming decade. [1]  Over $10 trillion in private wealth will change hands in North America over this time frame, the largest transfer of private wealth in history. [2]

There certainly is capital out there currently sidelined and looking for good investment opportunities.  If you have an attractive and salable business, and you are ready, now may be the time to put it on the market given that the increasing supply of businesses for sale over the coming decade will put downward pressure on sale prices.  Under these conditions buyers will only pay top dollar for the most attractive businesses and those that come to market unprepared will risk selling for a significant discount or face liquidation altogether.

Effective pre-sale planning must begin at least 3 years prior to sale and should begin with a business valuation.  A current valuation provides: 

1. An indication of what the business owner could reasonably expect to fetch on the open market (i.e. managing value expectations will increase your odds of getting a deal done); and

2. A benchmark for enhancing the value of the business prior to an actual sale.  

The business valuation process involves a careful assessment of the company’s risk profile and the key value drivers for the business.  A valuation conducted by a professional valuator will identify areas of weakness to focus on to increase the attractiveness of the business to a potential purchaser.  Beginning early enough allows time to implement the key value enhancement initiatives required to maximize the price that is ultimately received in a sale.  

All business owners will eventually exit their business.  The importance of pre-sale planning must not be overlooked.  In a Newport Partners survey of more than 100 Canadian business sellers, 62% recommended methodically pre-planning the sale of a business two to three years in advance.  Less than 25%, however, actually did so themselves.  Success can be achieved by learning from the mistakes of others.  

Pre-sale planning is especially vital in light of existing demographics and the expected increase in the supply of businesses that will be put up for sale over the coming decade.  The planning begins with a business valuation so there is a frame of reference for measuring the effectiveness of the pre-sale planning activities.  Without one business owners may never realize just how much money was left on the table.

Contact us at jason@vspltd.ca or www.vspltd.ca to start your pre-sale planning process with an independent business valuation.

1.  As per the Canadian Federation of Independent Business (CFIB) and the CICA/RBC Business Monitor (Q1 2010).

2.  Source: The $10 Trillion Opportunity, Richard Jackim & Perry Phillips, 2007.

8 Ways to Tell if You Are Building a Business or Just Have a Job

The ultimate test to determine if you own a valuable “business” or just have a “job” can be found in a simple question: would someone want to buy your company?  

Would your customers continue to do business with the company (and its new owners) after you are gone?  In other words, will the revenues and discretionary cash flows generated by the business continue after your departure?  This is a major issue for many smaller personal services businesses that have few, if any, employees and are very dependent on the owner(s) for generating business and performing specialized services.  

If you are planning to one day sell your business you should address this issue now to understand what, if anything, must be done to turn your “job” into a salable “business”.  Whether you want to sell next year or a decade from now, you must build an asset someone would buy – otherwise, you have a job, not a business. 

Here are eight ways to ensure you are building a salable business and not just doing a job:

1. A job requires that you show up at work to make money, whereas a business generates revenue whether you are there or not.

2. If your company is so reliant on a single customer that they can dictate how you deliver your product or service, your company is more like a job than a valuable business.

3. A job is a place where your personal reputation impacts your results, whereas a business is a place where the brand is more important than the personality of the founder(s).

4. A job requires you to use your personal experience and expertise to get a result, whereas a business is a place where a process – not a person – consistently produces a desirable result.

5. In a job, you get fired for taking too much vacation, whereas if you own a business, the more vacation you can take without impacting your company’s performance, the more valuable your business will be.

6. In a job, the harder you work, the more money you earn.  In a business, the smarter you work, the more money you earn.

7. In a job, you solve the problems. If you own a business, your employees solve the problems.

8. If the majority of your customers know your personal phone number, it’s likely you have a job, not a business.

If you are unsure as to the extent to which you own a valuable “business” or just have a “job”, you should get your Sellability Score.  Whether you are looking to sell now or in a decade, the Sellability Score assessment allows you to see your business as a potential buyer would see it and to identify areas to focus on continue building a salable business. 

Complete the Sellability Score questionnaire at www.sellabilityscore.com/vsp/jason-kwiatkowski and we will send you a summary report showing just how your business stacks up on the “job” versus “business” issue.

How to Minimize Costs in a Matrimonial Separation

A sobering statistic for many is that over 40% of marriages will end in divorce before the 50th year of marriage. [1]  This does not exclude business owners and a matrimonial separation can result in significant professional fees for business owners, especially when the value of the business is a key area of dispute.  An independent business valuation can help to minimize legal and expert fees for business owners going through a matrimonial separation.

 

The division of property is a major issue in a matrimonial separation.  According to the Ontario Ministry of the Attorney General [2]:

"When a marriage ends, … the value of any property that was acquired by a spouse during the marriage and still exists at separation must be divided equally between the spouses.  Also, any increase in the value of property owned by a spouse at the date of marriage must be shared.  The payment that may be owed to one of the spouses in order to effect this sharing is called an equalization payment, or an equalization of net family property."

Upon separation a net family property (NFP) statement is prepared setting out the value of the assets and liabilities of each spouse as at the date of marriage and the separation date.  Privately held business interests (i.e. shares, stock options, restricted stock, etc.) constitute property, the value of which must be included in the NFP statement.  The assistance of a Chartered Business Valuator will likely be needed where there are business interests and the parties cannot mutually agree on the value of the those interests as at the marriage date or the separation date. 

 

Depending on the separation process (i.e. collaborative, mediation, litigation, etc.), the parties may agree to jointly retain one independent business valuator to value the business interests.  One party, however, may opt to individually retain an independent business valuator.  The other party will often then retain a separate independent business valuator to review, critique and respond to the other expert’s report.  This can be a costly process. 

 

Where spouses disagree over the value of the business significant legal and expert business valuation fees can be incurred towards various activities relating to the value of the business interests (e.g. document productions, discoveries, legal motions, expert reports, negotiations, critique reports, trial, etc.).  This can become a very costly, time consuming, and emotionally draining process. If the business valuation issue becomes very contentious, professional fees can quickly escalate to well over $100,000. 

 

Obtaining an independent business valuation for a fraction of this cost can help avoid a disagreement over value in the event of a marital breakdown, which is well worth it if it saves hundreds of thousands of dollars in professional fees.  By not having an independent business valuation (and discussing this issue with your spouse) you increase the chances of there being a dispute over the value of the business in the event of a matrimonial separation.

 

Contact us at jason@vspltd.ca or www.vspltd.ca to find out more about the business valuation process and the types of valuation reports that CBVs provide.

 

 

1.  Source: www.statcan.gc.ca, CANSIM Table 101-6511.

2.  Source: www.attorneygeneral.jus.gov.on.ca.

Avoiding Costly Shareholder Disputes

Business ownership can be complicated, particularly when there are multiple shareholders.  The odds of disagreement and conflict among shareholders over various issues can be very high.  When shareholder relationships break down there must be a mechanism in place for dealing with the dispute or for enabling one or more of the shareholders to exit the business in a pre-determined manner. 

 

A shareholder buyout can quickly turn into a costly dispute if the value of the business has never been discussed and agreed to among the shareholders.  Different shareholders likely have different expectations regarding the value of the business.  Having an effective Shareholder Agreement and obtaining an independent business valuation can help avoid a very costly, time consuming and emotionally draining shareholder dispute.

 

I have been retained in many shareholder disputes to provide an independent expert business valuation for purposes of determining a price at which the departing shareholder’s shares should be acquired by the remaining shareholder(s) or redeemed by the company.

 

In my experience, these disputes can be devastating to the business as well as the individuals involved.  The shareholders become distracted and ultimately exhausted from preparing for and attending discoveries, meetings with lawyers and experts, settlement negotiations and arbitration or court proceedings.  Relationships are destroyed and ultimately the business suffers because the shareholders are no longer devoting sufficient time and attention to managing the company’s operations.

 

The importance of a Shareholder Agreement to privately held business owners cannot be over emphasized.  An effective Shareholder Agreement should address the following areas: i) compensation; ii) decision making; iii) entrance; iv) exit; and v) return on investment.  Privately held company shares are illiquid assets and the Shareholder Agreement should provide the shareholders with the means to liquidate an otherwise illiquid asset under certain triggering events.  For example, a buy-sell provision (or "shotgun" clause) allows for one shareholder to offer to buy the shares of another shareholder subject to the right of the other shareholder either: i) accepting that offer; or ii) buying the shares of the offering shareholder at the same price offered by that shareholder.

 

With respect to the valuation of the business and the individual shareholdings, the Shareholders Agreement should provide a definition of value (e.g. fair market value or fair value) and set out the process and timing for obtaining an independent valuation.  Many Shareholder Agreements stipulate that an annual or biennial valuation of the business should be prepared by an independent Chartered Business Valuator (CBV).  This independent valuation forms the basis for new shareholders to buy-in and for existing shareholders to exit or measure their return on investment. 

 

Committing to a formal business valuation allows the shareholders to discuss and agree to the value of the business before any potential disagreements arise.  In the event of a shareholder buyout, the valuation issue will have already been addressed.  The return on investment to the shareholders will be substantial if it means avoiding a costly, time-consuming, emotionally draining and perhaps devastating shareholder dispute down the road.

 

Contact us at jason@vspltd.ca or www.vspltd.ca to find out more about the valuation process and the types of valuation reports that CBVs provide.

Business Valuation – Critical to Enhance Value and Manage Wealth

As a business owner, the value of your business likely represents a significant portion of your wealth.  According to a publication by Mercer Capital:

"About 75% of all private equity is owned by households for whom it constitutes at least half of their total net worth. Households with entrepreneurial equity invest on average more than 70% of their private holdings in a single private company in which they have an active management interest."  [1]

Enhancing and managing this privately held business wealth is critical to business owners and this process begins with an independent business valuation.

 

Value Enhancement

 

The process of enhancing the value of your business begins with a business valuation which provides a benchmark from which to measure value increases over time.  The valuation process will also identify key value drivers to focus on to enhance the value of the business.

 

Resulting value increases will provide a significant return on the investment in a business valuation and value enhancement initiative.  We have seen clients double their business value within a two year period http://jasonkwiatkowski.blogspot.ca/2013/12/how-to-double-value-of-your-business-in.html).

Potential purchasers will be very impressed if you have documented how you increased the value of your business over time and identified opportunities for further growth and value enhancement.  Your chances of attracting numerous suitors and securing a deal for top dollar will be greatly increased.

 

Wealth Management

 

In order to effectively manage your wealth you need to know the value of your assets, including your privately held business.  Annual fees are paid to wealth managers to manage your liquid investments (e.g. publicly traded securities).  Monthly statements are provided setting out the value of these investments to assist with decision making.

 

Privately held business owners often spend significant time managing the business but little time managing the wealth associated with their business.  An effective wealth management strategy allocates a percentage of the value of the business to managing this privately held wealth.

 

The One Percent Solution suggests recommends for business owners to invest 1% to 2% of the value of the business towards a "wealth management budget" which includes, among other things, an annual business valuation and monitoring critical success factors and key value drivers.

 

 

All business owners will one day exit their business.  An independent business valuation can help you identify what percentage of your overall wealth is tied up in the business and identify key areas to focus on to enhance the value of your business.

Contact us at jason@vspltd.ca or www.vspltd.ca to find out more about the valuation process and how it can help enhance the value of your business and manage your wealth.

 
1.  Source: The One Percent Solution, Z. Christopher Mercer, 2007.

Business Valuation – Critical for Managing Value Expectations

Are you trying to build a business to one day sell for top dollar?  If so, it is critical for you to manage your value expectations and to be aware of how your business will be perceived and valued by potential purchasers.

 

Many business owners have unreasonable expectations regarding the value of their business.  According to RBC Business Succession Planning: Your Essential Roadmap, "It is important to get a professional business valuation, since owners may grossly overestimate or underestimate the value of their business."

 

Some business owners overestimate the value of their business and others actually underestimate the value of their business.  I have seen both situations before and there are serious implications to erring on one side or the other.  

 

Implications of Overestimating Value

 

Business owners that overestimate the value of their business may do so because they place too much emphasis on sweat equity or they ascribe value to the personal goodwill associated with the business.  Sweat equity refers to the effort and time put into the business and personal goodwill refers to the value associated with the personal skills and abilities of the business owner which are not commercially transferable.  A potential purchaser will not be willing to pay for the business owner’s value expectations if the company financials do not support them.

 

A potential purchaser is interested in future cash flows.  When the target’s cash flows (current or future) do not support the business owner’s value expectations, this creates a (potentially significant) gap between what a potential purchaser is willing to pay and what the business owner expects to receive.  The larger this value gap the greater the risk of not getting a deal done.

Implications of Underestimating Value

 

Business owners that underestimate the value of their business may do so for many reasons.  They may not understand how a potential purchaser values a target company.  They may not appreciate the value associated with various intangible assets they have created (e.g. customer relationships/contracts, intellectual property, proprietary technology, goodwill, etc.).  They may have based their value expectations on outdated or inappropriate industry rules of thumb.

 

A potential purchaser may see value that you were not aware existed, especially if you are dealing with a strategic purchaser. [1]  The price paid in an actual transaction is the result of a negotiation and a potential purchaser will rarely put forth their best offer initially.  If you are not armed with the ability to understand and justify the value of your business to a potential purchaser you run the risk of leaving significant money on the table.  You may be inclined to accept an initial unsolicited offer without attempting to negotiate a higher price based upon valuation principles and valid assumptions.

 

The consequences of overestimating or underestimating the value of your business can be severe.  An independent business valuation conducted 3 to 5 years prior to sale allows you to manage your value expectations and enter meaningful negotiations with a potential purchaser, provide reasonable justification for your value, increase your chances of getting a deal done and not leave money on the table in the process.

 

Contact us at jason@vspltd.ca or www.vspltd.ca if you want to manage your value expectations and minimize your risks with an independent business valuation.

 

 

1.  A strategic purchaser is one who believes it can enjoy post-acquisition economies of scale, synergies, or strategic advantages by combining the acquired business interest with its own.

5 Ways to Position Your Company to a Strategic Purchaser

Facebook’s recent acquisition of WhatsApp for $19 billion represented the largest-ever acquisition of an Internet messaging service company in history.

 

WhatsApp allows users to avoid text-messaging charges by moving texts across the Internet instead of the mobile phone carrier networks.  This can save people who travel, or live in emerging markets, hundreds of dollars a year.  As a result, WhatsApp is adding about one million new users per day.

 

At the time of the acquisition in February 2014, WhatsApp had some 450 million users and, after the first year, charges users a subscription of $1 per year.  Even if all 450 million WhatsApp users were already paying, that is still less than half a billion in revenue.  Why would Facebook acquire WhatsApp for a number that is somewhere north of 40 times revenue?

 

It is possible that Facebook sees the opportunity to sell more Facebook ads because of the information they gather from WhatsApp users.  Global advertising giant Publicis estimates 2013 online advertising spending in the US alone to be around $500 billion.  Presumably Facebook believes they can get a larger chunk of the global online ad buy because they know more about its users by owning WhatsApp.

 

Therein lies the definition of a strategic acquisition.  Most acquisitions run a predictable pattern of industry norms, but a strategic purchaser can pay a significant premium for your business because they are looking at your business for what it is worth in their hands.  Rather than forecasting out your future profits and estimating what that cash is worth in today’s dollars, a strategic buyer is calculating the economic benefit of combining your business with theirs.

 

There can be many "strategic" reasons why a larger company might want to buy yours. Here are 5 to consider:

1. To control their supply chain (i.e. you are a key supplier)

In 2011, Starbucks announced it had acquired Evolution Fresh, one of their providers of juice drinks, for $30 million.  This allowed Starbucks to be less dependent on one of its suppliers.

2. To enhance sales (i.e. you provide an opportunity for the purchaser to increase its sales)

In 2011, AOL announced the acquisition of The Huffington Post for $315 million, even though HuffPo had just turned its first modest profit on paper.  AOL wanted to give its advertising sales people more inventory to sell and HuffPo had 26 million unique visitors a month.

3. To make their products look sexier (i.e. your product enhances the purchaser’s products)

In 2011, Microsoft bought Skype for $8.5 billion even though Skype was losing money.  It is possible that Microsoft expected to sell more Windows, Office and Xbox products by integrating Skype into everything they already sell.

4. To enter a new geographic market (i.e. you offer an expansion port for the purchaser)

In 2012, Herman Miller paid $50 million to acquire POSH Office Systems (a Hong Kong based designer, manufacture and distributor of office furniture) in order to get a foothold into the world’s fastest growing market for office furniture.

5. To get a hold of your employees (i.e. your employees are valuable to the purchaser)

Facebook reportedly acquired Internet start-up Hot Potato for $10 million, largely to get hold of the talented developers working at the company.

Most acquisitions are done for rational reasons where an acquirer agrees to pay today for the rights to your future stream of cash.  You may, however, be able to get a significant premium for your company if you can figure out how much it is worth in a specific purchaser’s hands.

 

Curious to see what your business is worth and how you might improve its value to both strategic and financial acquirers? Contact us at jason@vspltd.ca or www.vspltd.ca.  You can also complete the Sellability Score questionnaire and we’ll send you a custom report complete with your score on the eight key drivers of Sellability.  Take the test now: http://www.sellabilityscore.com/vsp/jason-Kwiatkowski.