What Is My Company Worth?
In this article from our Q2 2008 Newsletter, ASG Principal Ed Kirk explains how to formulate a basic idea of your company's market value, and when to ask for help.
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For most owners, the question of value is a practical one. A clear understanding of what your company will fetch on the market will allow you to plan confidently for retirement. In contrast, misperception of value can lead down a rocky path. The story of the owner who believed his or her company was worth more than the market was willing to pay has been repeated countless times; it almost always ends with a sad choice between delaying retirement and compromising retirement lifestyle.
To avoid such a decision, determine the market value of your company as early as possible and revisit the valuation about once a year. Don’t pursue a sale until the amount you will net, after taxes and other costs, is enough to meet your financial goals for the next phase in life.
The sale price of a company depends on two separate, but closely related factors—what a buyer is willing to pay, and how much a bank is willing to lend to finance the acquisition. The buyer who purchases a company out-of-pocket is rare; even private equity acquirers with large war chests of cash typically use leverage to finance up to 80 percent of the price of companies they acquire. The amount a buyer is willing and able to pay therefore almost always depend in part on how much they are able to borrow for financing the acquisition.
Banks will look at the assets available within the company to collateralize the loan, as well as the acquired company’s ability to service the debt with cash flow. Regardless of collateral assets, lenders and buyers alike want the company to maintain a reasonable cash flow cushion—perhaps 25 percent—beyond the amount needed to keep up operations, pay management salaries, and service loans.
As a starting point to determine the value of your own business, it is worthwhile to note that most companies sell for a multiple of two to six times earnings before interest, tax, depreciation and amortization (EBITDA). Exactly where a particular company falls on this spectrum depends heavily on the following factors:
Management. Acquirers want an investment that will continue to grow and prosper even when the company’s founder departs. Having a strong, tenured management team that can run the business successfully after the ownership transition adds to the value of a company.
Diversification. Single products or large customers that contribute disproportionately to sales or profits may imply risk to acquirers and their banks. Companies whose revenue comes from a broad array of customers, products, and geographic regions often sell for higher multiples.
Competitive or strategic benefits. Companies with strong, sustainable competitive advantages are valued highly. Acquirers are buying a company’s potential, and a strong strategic vision indicates a promising future.
Predictability and potential for growth. Buyers generally perceive less risk with companies whose revenues and profits are very predictable. They also see more upside with companies that have significant growth potential. In either case, acquirers may be willing to accept a lower return, which translates into a higher price for the seller. By contrast, acquirers generally want a higher return when they perceive greater risk, and the result for the seller is a lower price.
Assets. Banks often are more comfortable lending money to finance the purchase of asset-intensive companies. If the business takes a turn for the worse, this collateral can be sold off to repay the bank debt. Moreover, some acquirers appreciate asset-rich companies for the competitive barrier that the assets provide. On the other hand, asset-intensive companies require greater expenditures to fuel growth and therefore are not as attractive to some buyers.
Pinpointing market value with more precision is a complex task that might fairly be called equal parts science and art. Ultimately, a company’s price tag will be impacted by a combination of customers, suppliers, employees, market conditions, management, competition, consistency of cash flow, assets, contracts, quality of financial records, and many intangibles that fall under the category of “goodwill” and take years to develop.
If you are considering an eventual sale, we invite you to call us at 425-450-4800, or email info@asgpartners.com. ASG Partners performs valuations free of charge.
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