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  They may have based their value expectations on outdated or inappropriate industry rules of thumb.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.

10 Reasons to Invest in a Business Valuation

Many business owners do not know the current value of their business, which can represent a significant portion of their overall wealth.  Worse yet, many business owners will grossly overestimate or underestimate the value of their business.

 

A Chartered Business Valuator (CBV) or Accredited Senior Appraiser (ASA) can provide you with this extremely valuable information.  Some business owners are reluctant to undertake this exercise because of the cost.  They do not appreciate that the benefits of obtaining an independent valuation can far outweigh the cost.

 

Obtaining an independent, professional business valuation for planning purposes does not have to be an expensive endeavor.  The cost will depend on the size and complexity of the business and the type of report that is required.  The cost to have a CBV prepare a Calculation Valuation Report, however, can be quite reasonable and this type of valuation report is generally sufficient for planning purposes.

 

Obtaining an independent business valuation and understanding the value of your business is one of the cornerstones of an effective exit planning process.  There are many reasons to invest in a professional business valuation, including:

 

1. Manage value expectations – an independent valuation can increase your chances of getting a deal done since many business owners will overestimate or underestimate the value of their business
 
 
2. Wealth management / enhancement – a valuation helps to identify key value drivers and provides a benchmark for measuring value enhancement
 
 
3. Shareholder buy-out or dispute – provide a value for shareholder buy-out or, more importantly, help avoid potential future legal disputes over value (i.e. full disclosure to all shareholders)
 
 
4. Matrimonial separation or dispute - provides support for value of the business to be included in net family property (NFP) statement or, more importantly, help avoid potential disputes over value upon separation
 
 
5. Pre-sale planning - buyers will only pay top dollar for the most attractive businesses.  A valuation can help document the increase in value over time and help the business become more liquid
 
 
6. External sale - use as a basis for negotiations with potential purchasers (e.g. determine asking price, assess unsolicited offer, etc.)
 
 
7. Internal sale - establishes a price for a management buy-out, employee share ownership plan or transfer to the next generation
 
 
8. Tax and estate planning - provides support for the value being transferred and acts as insurance for potential disputes with CRA (e.g. estate freezes, reorganizations, related party transactions, etc.)
 
 
9. Life insurance coverage - provides guidance for amount of life insurance coverage to obtain (e.g. key person, fund buy-sell agreement, fund taxes on death, etc.)
 
 
10. Trustee / executor protection - protection against possible estate administration tax (EAT) reassessments
 

The benefits of having a professional valuation far outweigh the costs.  In our experience, a Calculation Valuation Report is suitable for planning purposes and can generally be prepared for less than $10,000.  The valuation process can help uncover key value drivers to potentially double the value of your business within a few years.  Two of our recent clients at VSP were able to double the value of their business in a two year period.

 

Obtaining a professional valuation can also help minimize the legal and other expert fees if you are ever faced with a shareholder dispute or matrimonial separation.  The value of the business is often a very contentious issue in these matters and legal and expert fees (i.e. for a business valuator) well in excess of $10,000 are routinely incurred as a result of this issue alone.

 

Follow me over the coming weeks as I explore the above noted reasons in more detail.  Contact us at jason@vspltd.ca or www.vspltd.ca if you would like to maximize the value of your business and minimize potential legal and expert fees in the event of a separation (shareholder or matrimonial).

 

 

VSP to Make Guest Appearance on Exit Coach Radio

At VSP we are committed to helping business owners prepare for a smooth exit from their business.  As a certified exit planning advisor with professional business valuation designations in Canada and the United States, I believe that having realistic expectations with respect to how a potential purchaser would value your business and knowing how to enhance the value of your business before exit is critical to ensuring a smooth transition to new ownership.
 

Proper planning, including obtaining an independent business valuation, is also critical for avoiding potential disputes and costly litigation (matrimonial or shareholder disputes).  Far too often I have seen spouses and business partners  spend a significant amount of time, effort and money in litigation over disputes regarding, among other things, the value of the business.  This is one of the reasons why we developed the Exit Starter Program at VSP.
 

I am also very pleased to announce that, as a representative of VSP, I will be a guest on "The Exit Coach Radio Show" on Wednesday, February 26, 2014 at 3:25 pm EST.
 

Bill Black, host of The Exit Coach Radio Show, interviews top Advisors about various tips, ideas and precautions for age 50+ business owners.  He has over 275 episodes to date.  I will be talking about planning strategies that are important for business owners to grow and protect the value of their business.
 

I hope you will be able to tune in.  You can listen live from your computer by going to www.ExitCoachRadio.com and click on "live show" at the　bottom of the page.  If you miss the live show, a recording of it will be posted a few days later.
 

I look forward to your feedback.  Contact us at www.vspltd.ca or jason@vspltd.ca to find out more about the VSP Exit Starter Program or to speak with a certified exit planning advisor with business valuation designations in Canada and the United States.

Selling Your Business in the Coming Decade? It Pays to be Prepared

Proper preparation will greatly increase your chances of maximizing the net sale proceeds when you sell.  Although preparation takes time, effort and attention, the benefits of planning far outweigh the costs.

 

"Built to Sell" author, John Warrillow, discusses two such benefits in his recent blog entries (www.builttosell.com/blog/).  A takeaway from reading John’s recent articles is that proper preparation will greatly improve your chances of: i) selling for a significant premium; and ii) avoiding buyer trickery.  Let’s consider at each of these in turn.

 

 

Selling for a Significant Premium:

 

According to Mr. Warrillow’s recent research, companies that scored over 80 on The Sellability Score received an offer for the business that was 70% higher in value than the average offered to all companies.  John refers to this as the Sellability Premium.

 

The Sellability Score is an online questionnaire that provides a business owner with a report containing an immediate score of between 1 and 100 for the business and detailed information on the eight key drivers of sellability for your business.

 

Based on nearly 7,000 completed questionnaires over the past year, John’s research team found that the average valuation multiple offered for all businesses was 3.6 times pre-tax income.  Those businesses that scored over 80 on the Sellability Score, however, received an average offer of 6.1 times pre-tax income, or 70% higher.

 

Taking the Sellability Score 3 to 5 years before you plan to sell allows you to see where your business stands today.  You can identify areas for improvement to increase the value and salability of your business with enough time to implement the necessary initiatives before you put your business up for sale.

 

 

Avoiding Buyer Trickery:

 

Knowledge is power and being aware of the techniques used by buyers to acquire businesses on the cheap can enhance your negotiating strength and help you maximize your net proceeds on the sale. 

 

A summary of ways to defend against 5 common buyer strategies, according to John’s recent article, is summarized below:

 

1. The inflated working capital adjustment – after agreeing to an offer price, the buyer proposes a punitive working capital adjustment, forcing you to leave more of your money in the company.  You can defend against this by having the buyer spell out their proposal for calculating the normalized working capital before you sign the Letter of Intent (LOI);
2. The proprietary deal – the buyer gets you to sign an exclusive deal before you are able to create a competitive market.  You can defend against this by not signing an exclusivity agreement until you have shopped your company to a shortlist of strategic buyers;
3. The bait and switch – the buyer agrees to purchase your business for a certain amount but then drops the agreed upon price after the due diligence period when you are emotionally drained and already committed to the sale.  You can defend against this by assuming up front that the buyer’s price will drop 15% during due diligence, so only accept a LOI if you could live with selling for 85% of the original offer;
4. The 100% vendor take-back – the buyer agrees to your price but insists you finance all or most of the sale.  You can defend against this by insisting on at least 50% of the proceeds in cash so the buyer has something to lose if they can’t make a go of your business; and
5. The earn-out – the buyer agrees to a valuation for your business that includes an "at risk" portion of your proceeds in the form of an earn-out.  If your targets aren’t reached, the earn-out disappears.  You can defend against this by expecting an earn-out, but treating it as gravy.  Only sell if you would still be happy with the deal if the earn-out never materialized.

A very successful scientist, inventor and innovator once said "Before anything else, preparation is the key to success."  I believe this to be true and preparing to sell your business should involve taking the Sellability Score at least 3 to 5 years prior to the sale.

 

To find out your company’s Sellability Score: http://www.sellabilityscore.com/vsp/jason-kwiatkowski

 

I also believe that adequate preparation involves obtaining an independent business valuation 3 to 5 years prior to sale.  This will help manage your expectations on price and identify areas that need improvement to enhance the value of your business prior to sale.  Contact us at jason@vspltd.ca or www.vspltd.ca to speak with a professional business valuator that is also trained and certified in the area of exit planning.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9 Tips for a More Valuable Business This Time Next Year

The beginning of a new year is a time of rebirth and resolutions.  It is a time to reflect on last year’s achievements and to set goals for the coming year.

 

Some people set personal goals like losing weight or quitting a nasty habit, and most business owners set business goals that focus on hitting certain revenue or profit targets.  If your goal is to own a more valuable business in 2014, you should select one or more of the following New Year’s resolutions:

 

1. Take a two-week vacation without checking in with the office.  When you return, you’ll see how well your business ran without you and where you need to make a key hire or create a new system;
2. Write down one process per month.  You know you need to document your systems, but you may be overwhelmed by the task of taking what’s inside your head and putting it down in writing for others to follow.  Resolve to document one system a month and by the end of the year you’ll own a more valuable business;
3. Offload at least one customer relationship.  You may be your company’s best salesperson, but this can be a liability in the eyes of an acquirer, which is why you should wean your customers off relying on you as their point person.  By the time you sell, none of your key customers should think of you as their relationship manager;
4. Cultivate a new relationship with a new supplier. Having a "go to" group of suppliers is great, but an over-reliance on one or two suppliers can create a liability for your business.  By spreading some of your business to other suppliers, you keep your best suppliers hungry and you can make a case to an acquirer that you have other sources of supply for your critical inputs;
5. Create a recurring revenue stream.  Valuable companies can look into the future and see where their revenue is going to come from.  Recurring revenue models can vary from charging customers a small amount for a special level of service to offering a warranty or service contract;
6. Find your lease (and any other key contracts).  When it comes time to sell your company, a buyer will want to see your lease and understand your obligations to your landlord.  Having your lease handy can save time and avoid any nasty surprises at the eleventh hour in the process of selling your company;
7. Check your contracts and make sure they would survive the change of ownership of your company.  If not, talk to your lawyer about adding a line to your agreements that states the obligations of the contract "surviving" in the event of a change of ownership of your company;
8. Start tracking your Net Promoter Score (NPS). The NPS is the best predictor that your customers will re-purchase from you and/or refer you, which are two key indicators of a healthy and successful company.  It’s also why many strategic acquirers and private equity companies use NPS as a way to measure the health of their acquisition targets during due diligence; and
9. Get your business professionally valued. All goals start with a benchmark of where you are at today, and by understanding your company’s current value (from the perspective of a potential purchaser) you can identify which aspects of your business to work on to increase its value.

Many business owners will set New Year’s resolutions around their revenue or profits for the year ahead, but those goals are rudimentary.  Instead of just building a bigger company, consider making this the year you build a more valuable one.

 

Building a more valuable business becomes critical if you are planning to exit your business in the coming decade and want to maximize your net sale proceeds.  Contact us at jason@vspltd.ca or www.vspltd.ca for an independent business valuation or to see if you qualify for our VSP Exit Starter Program in 2014.

 

 

How to Double the Value of Your Business in Two Years

As we approach the beginning of a new year I reflect upon our firm’s achievements and challenges over the past year.  Celebrating accomplishments and monitoring progress towards goals are vital to your continued focus, commitment and motivation.

 

How did your business do this year compared to your original goals?  Are you on track to exit your business at a time of your choosing?  Has your business increased in value over the past year?  Would you like to double the value of your business within a two year period?  It may be challenging, but it can be done. 

 

Smaller start-up companies can increase in value quite quickly, particularly if they are able to create their own market or are successful at penetrating and finding a niche in an existing but growing industry.  Increasing the enterprise value [1] of a larger and more mature company, however, is generally much more difficult. 

 

Two of our clients at VSP this past year actually doubled their enterprise value within a two year period - and these clients were not small, start-up companies.  Having conducted a business valuation two years earlier, we were asked to update our valuation this past year.  One was required for tax purposes and the other was required for planning purposes in connection with a potential shareholder buyout.  One business has been a service provider for 15 years and had over $30 million in annual sales.  The other company has operated as a manufacturer for over 40 years and had over $50 million in sales. 

 

You may be wondering how two mature businesses in separate industries were able to double their enterprise value in two years.  A quick review of our valuation analyses reveals the following top 5 common factors contributing to this achievement:

 

1. A Business Plan - both companies had business plans in place two years earlier which included financial projections showing modest growth rates in sales and EBITDA going forward;


2. Recent Growth - both companies experienced recent growth and actually exceeded the sales and EBITDA targets set out in the financial forecasts from two years earlier;


3. Future Growth - both companies had updated their business plans from two years earlier and increased their financial forecasts going forward.  The fact that earlier projections were documented and the company actually exceeded targets enhanced management’s credibility with respect to the growth projections going forward;


4. Tangible Asset Backing - in order to support the recent and future growth, both companies had reinvested in the business thereby increasing the net tangible operating assets over the past two years; and


5. Reduced Risk Profile – as a result of both controllable (i.e. internal company specific) and uncontrollable (e.g. external market conditions) factors, both companies decreased their risk profile (i.e. lower discount rate or capitalization rate) thereby increasing the valuation multiple.
 

Any increases in redundant assets owned by your business (e.g. non-operating assets such as excess cash or marketable securities) or decreases in interest bearing debt outstanding will increase the value of your equity interest over and above the increases to enterprise value noted above.

 

It may not be easy but concentrating on these 5 factors will go a long way towards helping you double your business’ enterprise value in a two year period.  If you are planning to exit your business in the coming five years now is the time to get focused.

 

An independent business valuation can help measure your value increases over time.  This becomes critical if you are planning to exit your business in the coming decade and want to maximize your net sale proceeds.  Contact us at jason@vspltd.ca or www.vspltd.ca to see if you qualify for our VSP Exit Starter Program or want to document your value increases over time with an independent business valuation.

 

 

1.  Enterprise value represents the value of business operations attributable to both equity and debt-holders.