Making Sure The Price Is Right
What's your business really worth? Admit it--you're curious. It's hard not to wonder when publicly traded companies are hovering near all-time highs. And if you don't know, you're flying blind. A company's value can be crucial for a host of decisions, including how much you can borrow, whether you need an estate plan, and what to do when events sneak up on you.
Take Ralph VanTielen, the 56-year-old owner of VTE in Pellston, Mich., 300 miles north of Detroit. He didn't know how to respond last year when two separate bidders approached his plastics company with buyout offers. VanTielen founded VTE in 1982, building it cheaply with auctioned machinery into a $1.8 million company with 24 employees that makes rubber insulator caps for electrical batteries. "We had a basement mentality," he says. "We didn't realize we were sitting on something of value."
So VanTielen called in appraisers from Boston-based Carpenter Hawke & Co., who confirmed that the offers were indeed fair--they pegged VTE's value at roughly $2.6 million, or about 7.6 times free cash flow. But they also pointed out changes that helped boost cash flow by 35%--and thus lifted VTE's value. The upshot: VanTielen decided to hold on. "I found out that I probably am better off not selling," he says.
At least he knows for sure. Barely half of all owners have done a valuation, says a survey from Arthur Andersen's Enterprise Group, and they're probably pleased by the results. Demand for small, private U.S. companies is robust, with the average sale price rising 9% last year, according to VR Business Brokers in Huntington Beach, Calif.
Valuing a company is less of a guessing game than it used to be, thanks to growing databases of comparable sales, such as BizComps and the Institute of Business Appraisers. Still, it remains an art. "Each business is like a fingerprint," says Gary E. Jones, president of business-valuation service ValueNomics Research Inc. in Cupertino, Calif. "They're all different--even when they're in the same industry."
First, forget about the Dow averages and dot-com mania. "The stock market is not relevant to the private market," says Charles Hocker, a Dallas-based business broker. "It's hard when you look at a public company that sold at 26 times earnings, but those are two different worlds." In fact, private companies are lucky to fetch five times earnings, a multiple that hasn't changed much during the long bull market (table, page 14).
That's because in the private world, cash rules. "What buyers value most is predictable and growing cash flow," says William L. Walton, CEO of Allied Capital Corp., a Washington-based lender to private companies.
More specifically, the value boils down to current and expected free cash flow--earnings before interest, taxes, depreciation, and amortization, minus any capital spending necessary to bring the business up to par. Buyers take present cash flow and project out five years, then set a price on those earnings that guarantees a decent return. The price will vary according to the likelihood that earnings will grow, based on clues such as whether your revenue growth and margins have been consistent. Companies with clean balance sheets are less likely to take a haircut than cyclical, debt-ridden prospects. "It's an exercise in common sense," Walton says. "If you look at a business that has been growing at 10%, and you see projections that it will grow at 25%, that's pretty unrealistic."
Certain intangibles also affect the value of a business. A technology company in Silicon Valley should command a higher value than a rival based in rural California because of the quality of the workforce and proximity to the industry's hub. An industrial manufacturer with five solid customers is likely to fetch a lower price than a similar-size competitor with 50 outlets because its revenue source is less diversified. A company that's big enough to go public might begin to trade at stock-like multiples of earnings or sales. And if you're selling to a "strategic" buyer--someone who'll use your company to expand his territory or product line--you might command a hefty premium.
Sorting this all out requires outside help. "I have a CPA I have a lot of faith in, but I would have no faith in his valuing my company," says Ed Vernon, a California entrepreneur who has been through the drill. "The most important thing in valuing a company is the knowledge of the market that exists during the time you're trying to buy or sell. That's not his business."
ONCE-OVER. A better choice would be professionals such as business brokers, certified valuation analysts (CPAs with more specialized training), or mergers-and-acquisition specialists. However, be aware that each group has a potential conflict of interest--brokers, for instance, work on commission and thus might want to lowball your company for a quick sale. Ask if they belong to a trade group such as the International Business Brokers Assn., which has a written code of ethics. Atlanta-based broker Catherine Bienert goes one better: She enlists an outside service to complete her valuations. "I keep it at arm's length," she says.
Before you sign with anyone, make sure they have some idea of what you do. When VanTielen needed a price tag for VTE, he queried several business brokers he found via the Web before settling on Carpenter Hawke. "I asked them what kind of work they had done before, what their strengths were, and the kinds of companies they had experience with," he says. Also, ask to review an actual selling memorandum to get a feel for terms, and get references from customers and trade associations.
The appraisal firm will be checking you out, too. It may start with a quick once-over of your company and its industry, comparing profitability, margins, and growth before it decides if the listing fits its skills. If not, you may have to find another appraiser.
After that, get ready to give your corporate laundry a thorough airing. Expect to produce several years' worth of financial statements and explain them in excruciating detail. That's what Ed Vernon had to do in 1994 when he was selling DAC, the Carpinteria (Calif.) maker of machinery for the optics industry he had started from scratch three decades earlier. It's time-consuming, and opening your life's work to judgment by strangers can be wrenching. "It's a long, painful process," he says.
How much does a business valuation cost? It depends on how big your company is. Something with less than $1 million in annual sales and organized accounts might be charged $5,000. A company with $10 million in sales could pay several times that amount because of its complexity. VanTielen figures he spent $18,000. Want a second opinion? A "review appraisal" will cost about a third of the original write-up.
One caveat: The cold number-crunching of a valuation may not match what you'll get from a real bidder with fire in his eyes. Different buyers have different priorities, says Michael S. Hoesly, president of the IBBA. On one deal he handled, the seven offers ranged from 1.5 to 7.6 times cash flow. "The spread from financial valuation to market valuation is very pronounced," he says. That's Business 101: An object's true worth is not what you say it is, but what a customer is willing to pay.