Getting the best price
Thursday, 7 February 2008
Last Updated: Thursday, 7 February 2008
By Andrew Kent
A medium-sized business with a strong profit history is not as easy to sell as it should be. It is often too big for the first-time buyer and too small for an initial public offering or leveraged buyout.
But medium-sized businesses can provide buyers with good rewards for little risk, and the key to getting the best price for one is demonstrating this to potential purchasers.
The way to do this is to get the sales process right. It is a three-step process to optimise the selling price for a business, involving careful planning, preparation and implementation.
Planning
Consider who are the most likely buyers, the best timing and whether you are prepared to stay on and help with the handover.
Most likely buyers could be:
- Industry participants, competitors, customers or suppliers.
- Management, with or without third-party involvement, (such as venture capital or private equity funds).
- Venture capital/private equity funds alone.
- Retired wealthy executives looking to run a business of their own.
Larger medium-sized businesses can also consider sale by way of public float on a stock exchange.
Timing is important. It is always better to sell when your company’s industry is in a positive rather than a negative phase. And it is better to try to sell according to your timetable rather than have the timing dictated by others or external circumstances.
Buyers with limited financial resources may require a purchase under terms, and buyers from outside the industry may seek a handover period to maximise the price from them.
Industry participants may be more aware of some of the pitfalls or negatives of your business, but on the other hand they may see significant vertical integration or consolidation benefits.
Preparation
Many businesses have been structured to suit their current owners. (They may own more real estate than is necessary for running the business, for example). This can be separated from the business sale and retained or sold separately.
Ensure that you can provide up-to-date, accurate and easily understood financial records of the business. Poor records will create doubt and uncertainty in a buyer’s mind, which will result in the buyer applying a discount factor to the price.
Implementation
When presenting a business for sale, the positives should be highlighted. Positives would include a history of sustainable profitability, competitive advantages, barriers to entry and identifying areas for improvement that have not been dealt with.
Be mindful that when you are selling a business, you are selling the future. The past is only relevant to give comfort with respect to what has been achieved. Businesses with a turnover of $5 million or more can generally provide a base for dramatic growth for new owners.
Because sales of businesses are singular events for most business owners, it is advisable for them to engage experienced advisers to assist with the business sale. It is wise to canvass the widest possible audience to attract potential business buyers – especially those from outside the relevant industry.
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By Andrew Kent
There can be a ten-fold difference between the lowest and highest prices people are paying for small businesses.
The latest BizExchange Index revealed an alarming trend of an increasing number of small business owners selling their businesses for less than a year’s earnings – they were virtually giving the business away.
The market punishes vendors who are poorly prepared and rewards those presenting quality businesses in a professional way.
When you are selling a business, it is very important to consider your potential buyers. For small business, the likely buyers fall into four categories.
- Your employees, suppliers and customers.
- The large number of potential new owners currently working for someone else.
- Experienced business owners.
- Family members.
In Australia, the first group tends to be the last to know that you are selling, despite the fact that they are recognised as a key buying group. Getting the best price from this market is complicated, which is why it is often the market of last resort.
The complication relates to the sharing of key information during the negotiations when it is still possible that the deal may not proceed and you may be left with a key stakeholder having significant unwanted knowledge of your business.
If this trust issue can be overcome then your knowledge of them can play a part in presenting the business in a positive light. For example, if one of your employees has an open ambition to be their own boss, then you can emphasis this aspect to them.
Alternatively, if a supplier or customer has shown significant interest in the operation aspects of your business, you may be able to demonstrate the advantages of them combining the two businesses.
By far the largest market for people looking to sell a small business is people currently employed elsewhere. Typically they are looking for a business that can provide a reliable income stream and a role that they will enjoy doing.
Unfortunately, the large volume of potential buyers is not necessarily translated into high prices. There are a number of reasons for this, the most significant one being that many of the potential buyers simply cannot finance the purchase.
While it is possible to get a better price by selling under terms – for example with payments spread over a period of time – this also introduces some risk in that the value of the business may be adversely affected by the new owner before you are paid in full.
A safer alternative is to assist them to obtain finance elsewhere. To do this, be prepared to provide some financial history to assist your prospective buyer to get their bank onside. You might also suggest they apply for a loan through BizExchange, which enables them to seek loans from multiple banks by filling out a single form.
If your potential buyers are in a position to afford the business, then the other key thing to promote is the lifestyle potential that the new business may offer. Perhaps it can offer them a sea-change or a tree-change, or the simple appeal of being their own boss.
Be aware that this is a very competitive market, with franchisors commanding most of the attention through high-profile marketing. To get the best price you are going to need to put forward a more compelling offer than the franchisors.
A significant part of this is that as an independent business owner they will truly be their own boss, and their business will be entirely theirs. At the same time, you will need to put some effort into matching the franchisor lifestyle messages in relation to the day-to-day experience of the business owner.
Experienced business owners will pay good money for things they value. The key is understanding what they value. Unlike the first time owners, they won’t be seeking a lifestyle. More than likely they will be looking for a business that can run itself day to day. They want a business they can bring into their existing business structures with a minimum of fuss and some immediate benefits, not only in terms of profit, but also in relation to potential cross promotions, referrals, and joint project work.
A business that depends on the owner operator on a day-to-day basis will not get top dollars. The market is demanding financial history, client lists, forward projections, documented procedures and methodology, etc. Buyers are looking for proof that the business is well run with a good track record and positive outlook.
All of the buyers are wary of deception; any dishonesty on your part will undermine their faith in the business and your presentation of it.
Buyers will discount a business that they don’t trust to try and cover for the unknowns. To get the maximum price it is also important to keep the unknowns to a minimum without drawing attention to the negatives.
A difficult one in this regard is how you handle declining industries. For example, revenue in the Whitsundays diving industry has declined by more than 50% in the past 10 years, with an even greater decline in the number of businesses. Sellers will be emphasising the lifestyle rather than the trend in revenue. But it is one thing to avoid an issue, another to lie about it.
To get the best price, be prepared to present your business so that it attracts the most buyers that can afford to purchase it. A great way to do this is to list it on an independent marketplace that will generate inquiries for you.
This will require that you having plenty of information at hand to respond to various inquiries about different aspects of the business. How you respond to these questions will often determine the price that people will be prepared to pay. If you are not comfortable with this process, then you should use a business adviser or business broker to present your business for you.
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By Andrew Kent
The latest BizExchange Index has revealed an alarming trend of an increasing number of small business owners selling their businesses for less than a year’s earnings. In effect they are virtually giving the business away.
While it is not the first time that a business has been sold for less than it earns in a year, this had previously been regarded as an anomaly – possibly the result of a forced sale through personal circumstances such as the death or injury of a key person.
The BizExchange team noticed that there was a scattering of businesses offered for sale at less than a year’s profit in the December quarter, but regarded them as outside the normal course of events.
For the latest BizExchange Index, which was an assessment of 5000 print and online advertisements for private businesses for sale during the March quarter, this scattering has become a significant number of small businesses in wholesale trade, retail trade, hospitality and transport – three of the traditional strongholds of small business.
While the retirement of baby boomers has been expected to put pressure on business valuation, BizExchange is surprised by the speed of the decline at the lower end, particularly as the peak of baby boomer retirement is not expected until 2009.
There is also anecdotal evidence to suggest that some business owners, particularly in the construction industry, are not even bothering to sell their businesses. And other research suggests that the majority of business owners are relying on the sale of their business to fund their retirement, so it would appear that many are not going to have the retirement they hoped for.
But it was not all bad news for business owners this quarter. Two of the micro-market segments (retail and hospitality) that went into decline at the lower end also had significant gains at the upper end, with the common price being relatively steady in the range of two or three times earnings. Construction businesses presented for sale also managed to maintain their value.
These results tend to indicate that people will pay for quality and highlight the importance of preparing a business for sale properly.
There was also good news at the larger end of town, with a return to the traditional rule of thumb that the larger the business the better the price-earnings multiple. This has been largely underpinned by the activity of private equity firms, which continue to pursue value in privately owned businesses.
Advisers have also adjusted their expectations, moving from a largely negative position last quarter to having a strong expectation that business values will hold steady for the next 12 months. This is not unreasonable, because the relatively low average earnings multiples at which businesses are selling represents a return on investment of between 25 to 50% – which should ensure that valuations for sound businesses don’t fall much further.
The contrast between these predictions and the bottom end of the micro business market are stark, but understandable.
Larger businesses are generally less reliant on the owner for their ongoing success, and so the departure of the owner in the sale process has less of an impact on the business valuation. Even in the micro market, the high variance between the bottom and top of the market is often representative of the quality of the business entity and its ability to operate independently of the owner.
Business owners contemplating selling in the next few years would do well to work on ensuring their business can run without them – it could make it 10 times more valuable. Another thing to contemplate is making the business bigger, perhaps buying competitors. A larger business able to operate independently of the owner is much more saleable.
Extract from BizExchange Index – March Quarter 2007
Full copy available for free from www.bizexchange.com.au
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Over a period of time an industry usually develops its own rules of thumb to value businesses. Supermarkets, for example, may sometimes be valued at, say, five weeks’ turnover, so weekly sales of $20,000 would mean a value of about $100,000. There are formulas that can be used to arrive at the approximate value of a business.
The sale of a business involves a long-term investment of time and money by the buyer with no immediate guarantee of return. Therefore one of the most important things that must be considered when calculating the value (and thus the sale price) of a business is its likely future profitability.
This is the main point in assessing the attractiveness of a business and should be the starting point for calculating a fair and acceptable price.
To estimate the potential earning power of the business the buyer will try to find out about past profits, past sales and operating margins. The buyer may need to call in an experienced accountant to investigate and analyse this information.
The accountant will need copies of financial statements and other records of the business for the past three years, plus the income tax returns for the business to make sure the figures being shown are the same as those that have been supplied to the tax office.
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A detailed breakdown of sales and operating costs for the past years can be analysed by the potential buyer to indicate the trends in the business. They will then be compared to other similar businesses in the same trade. The buyer is well aware that there are people who “cook the books” when they are looking for a sale, so approach the sale with honesty.
Don't be convinced the buyer will buy if you simply produce an impressive looking balance sheet (such financial records are useless if the business has suddenly collapsed, for instance).
The buyer may believe that records have been arranged to suit the seller's purpose. Show business tax returns to prove that tax has been paid on the high profits that are claimed to have been earned. Don't give evasive answers to the buyer's questions.
Don't give excuses. The potential buyer will know that refusal to give full explanations and information, or to have figures audited or examined by an independent adviser, means it would be better to walk away and cancel the whole deal.
What the buyer will check over
The first thing that a buyer must do in assessing a business is to review its track record and history and the way it operates. This includes a full investigation of the financial records, as well as its staff, customers, suppliers, competitors and its marketing procedures.
The things that the buyer will look at are:
- Financial records.
- Debtors and creditors
- Staff.
- Customers.
- Premises.
- Location.
- Competitors.
- Lease.
- Patents and trademarks.
- Outstanding legal matters.
- Insurance.
- Marketing methods.
- Licenses and permits.
- Stock (inventory).
- Assets.
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What the seller needs
There are three main things that the seller requires from the buyer:
Background and financial position. The seller must be convinced that the buyer is someone of good standing who will take over the business and look after the clientele and staff in the normal way. If the buyer has been a bankrupt or has a history of business collapses or perhaps a criminal record, then these matters will be of concern and will affect the seller's decision to proceed or to close off negotiations. The buyer needs to provide evidence to the seller via the broker of financial net worth. This is the case especially where there is a substantial amount of money involved in the transaction.
The seller wants a good offer. The seller of the business will want as high a price as possible and the buyer naturally will be wanting to outlay as little as possible. During negotiations the parties should really arrive at a fair offer that can be taken as the fair value of the business and which both parties are happy with. This fair offer may differ dramatically from the price originally listed and may be influenced by the appraisal of the business by the broker or by a separate valuation that has been commissioned by the buyer. In any event, the deal will have more chance of succeeding if the offer is a fair one.
A good deposit. The buyer must be able to put down a fair deposit to win the confidence of the seller. Generally a deposit of up to 10% of the purchase price is expected. If the deposit is too low, the seller will always feel that should the buyer breech obligations the amount at risk is not sufficient for the buyer to comply with the terms of the contract. For a seller to be seriously interested, the buyer must make a commitment by coming up with a reasonable deposit.
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Due diligence simply means everyone doing their homework and checking the business out. This is the legal term that professionals use; boiled down it amounts to using common sense to look at all areas of the operation to see if it is the sort of business one wants to buy.
Due diligence will involve a more detailed investigation of every area of business, starting from the financials down to production and even such things as who and what time the business is opened and closed.
Due diligence is usually carried out by the potential buyer, as well as the buyer's accountant and other business advisers. There are many businesses that go to the stage of due diligence only to fall over because things are revealed on a closer investigation that were not obvious at the initial discussions and negotiations.
Unfortunately, there are many sellers who make false representations, especially in the area of financials. At a proper due diligence meeting the financial figures don't always line up with that which was initially given to the business broker by some business owners.
It is a good idea at due diligence for the buyer to have a look at the business plan to see how the actual operation ties up with business planning projections.
It is important to be aware of the buyer's requirements when it is time for due diligence. Everything should be available and tidy because this will generate confidence in your business and, hopefully, speed up a sale.
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The seller will want the greatest return for the years of hard work put into the business. The buyer is only interested in the future, so both sides can put a different price on the same business while both are being quite reasonable.
Negotiation between the two parties is the process by which the gap between the two different prices narrow.
Before carrying out the final negotiations, the buyer will be fully aware of the book value of the assets and the maximum amount of money that he or she can pay for the business to obtain a return on the investment required.
The investment return needs to equal or better the buyer's salary plus a return on the equity. Negotiations will, as a rule, start at a price lower than has been asked.
Remember that negotiations will not be entirely in money terms. Other details such as the name of the business and job security of the staff should also be brought into discussion.
Other main points to be finalised include terms of payment, assistance by the seller during transition, and the conditions and terms to be included in the contract for sale and purchase.
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It may be best to put a low value on the assets (stock, plant etc) and make the goodwill figure a high amount because goodwill is not taxable as such. The buyer, however, will try and get the reverse: a high value for assets and stock so that they become a tax-deductible item and a low value for goodwill because this is not tax-deductible. (Note Capital Gains tax).
One way of bridging this conflict between the two parties is to have the assets valued highly and then the seller work in or act as a consultant to the business after the new owner has taken over.
The wages paid will be tax-deductible to the buyer and the seller will have to pay tax on income, but because of this saving to the buyer, it may be possible to give the seller a higher wage to make up for the tax paid. Usually in finalising the terms of payment the two parties, through their accountants, arrive at a fair compromise.
Assistance during transition
The buyer may want to have the seller assist for a short period after the sale so that the new owner can be introduced to important customers and be shown the procedures of how to operate the business in the most profitable manner.
The sale and purchase agreement
As a safeguard against any costly errors, legal advice should always be obtained before any agreement is drafted and signed.
The agreement should always be drawn up by a lawyer to ensure that all essential points are covered and that both parties know exactly where they stand. A typical sale and purchase contract should include:
- A description of what is being sold.
- The purchase price.
- The method of payment.
- A statement of how adjustments are to be handled (for example, as to stock).
- The buyer assuming responsibility for the business from a certain date.
- Warranties by the seller, if any (for example as to protection for the buyer against any false statements or inaccurate information supplied).
- The covenant of the seller not to compete within a certain time period or within a certain area.
- The time, place and procedure for "closing the deal".
Arriving at the price
Arriving at a fair price is always the biggest problem when the business is being sold. Methods of valuing a business are covered elsewhere in the material and will not be covered here. Valuation should always be carried out professionally to protect the interest of the seller.
Source: CPA Australia
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By Tom McKaskill
The value to the buyer in a strategic sale is created through the exploitation of some asset or capability acquired in the purchase. Using this to best advantage is the secret.
To release the value of assets or capabilities, the buyer of a business needs to deploy the product or service throughout their organisation or through their distribution channels. The faster that can be done, the quicker the buyer releases the potential profits from the acquisition.
What does this mean for the seller? Basically, the more easily and quicker the buyer can exploit the inherent potential of the acquisition, the more it is worth to the buyer – if you look at the investment in terms of the present value of a stream of future earnings.
The basic premise is that larger and earlier profits generated from the acquisition are more valuable than smaller and later profits. If you translate this into the value of the acquisition, it is obvious that the acquisition is worth more to the buyer at the point of acquisition if the benefits can be released earlier.
The opposite side of this argument is clearly that the business is therefore more valuable and therefore can be sold for a higher price.
Following this logic, the seller can best prepare the business for sale by recognising the need of the buyer to quickly integrate the new acquisition and then rapidly deploy the acquired asset or capability. Thus the more easily the products or services can be scaled, the more able the buyer is to exploit the acquisition potential.
The seller should thus examine the business to ascertain what it would take to dramatically scale up the appropriate strategic value asset or capability. So, given unlimited resources, what should the product or service look like at the point of acquisition? How should the business itself be structured to provide the best launch platform for integration and then scalability of the strategic asset or capability?
Scalability might involve many aspects of the business. For example, documentation, monitoring systems, specialised equipment, training aids for salespersons, demonstrators, installers, available capacity, lining up suppliers and distribution channels. Ask yourself -- what would need to be done to scale the activity by 50 to 100 times?
Part of the task of the business owner is to work out which corporation can best exploit the acquisition. In doing so, the entrepreneur is identifying which corporations have the capability, capacity and experience to best exploit the opportunity presented through the acquisition.
The entrepreneur should then proactively set about presenting this opportunity to the prospective buyers so that they can evaluate it. In bringing the opportunity to their attention, the entrepreneur should articulate what steps he or she has taken to ensure that the acquisition is well prepared for scaling the acquired asset or capability. In this way the entrepreneur is also showing the buyer that he understands the potential of the acquisition and also how much it is worth.
The final part of the puzzle in ensuring that the entrepreneur gets full value for that potential is to ensure that he has several potential buyers lined up for the time when he wishes to trigger a sale.
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By Tom McKaskill
Just after I started my last business in the USA in 1995, a company called Red Pepper was purchased by Peoplesoft for 25 times its revenue. Since then I have seen numerous examples of such deals in the internet space and in biotechnology.
Every time I mention these deals to friends I get the same response – “luck and timing”. Also that these things happen only in the internet and biotech sectors.
So if told you that I assisted a small sport travel business to get 40 times EBIT, you would start to question this view of the world. The fact is that any business that has the potential to enable a large corporation to exploit a large scale revenue opportunity can gain a significant premium on sale.
However, very few people understand how to set up such a deal. We have spent most of our lives believing that our businesses are worth some meager multiple of EBIT. In fact, if you talk to most professional advisers, investment bankers and business brokers, they will focus their analysis of your business on what profit you are achieving now and what your likely revenue and profit growth will be in the near-term future.
I will freely admit that such analysis makes good sense when you are dealing with conventional businesses, where the only value they contribute is the generation of revenue and profits through their own resources. But what of the business that can enable a large corporation to exploit a national or global opportunity?
Most private businesses are heavily constrained through lack of finance, limited capacity, poor access to large distribution channels, lack of skills and so on. The inhibitors to growth often prevent them from exploiting their underlying potential.
In the hands of a better resourced and more capable buyer, the underlying potential can be more quickly achieved. Even so, most companies can only generate reasonable increments of growth due to the competitive nature of the market they are in.
But what if you had a world class product or service that had a clear competitive advantage? Could you find a large corporation that could exploit this advantage on a national or global scale to achieve 50 or 100 times your revenue in a relatively short period? This is the basis of a strategic value sale.
The fuel for such an opportunity lies in the assets and capabilities that a large corporation can exploit, usually within an existing large customer base. The process of setting up such a deal starts with an examination of your own assets and capabilities. What do you have or do that could provide the basis for resolving a serious threat or enabling a large scale revenue opportunity for a large corporation?
Often these are things that now provide your competitive advantage, but they may also be things that you are not exploiting in your own business but which some other business could.
Next, you need to determine whether you can provide the buyer with some reasonable period within which they can exploit the asset or capability without it being copied, eroded or negated by an aggressive competitor. Something that can be easily acquired, assembled, developed or negated is of little interest to a large corporation. Next you need to identify which large corporations can exploit the opportunity.
Now you have the basis for setting up a deal where you potentially could achieve a sale price of many times EBIT or revenue.
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By Tom McKaskill
If you have something that is attractive to a large corporation, then you should take the time to work out how you can make it more valuable before you put yourself on the auction block.
Large corporations are especially interested in assets or capabilities that they can leverage quickly to create large revenue gains.
To secure a premium for such an asset or capability, however, you need to be able to provide the buyer with some reasonable proven period of competitive advantage during which this has been exploited.
Remember, something that can be readily copied, negated, created or purchased has little strategic value.
Once you have identified that you do have something that can be leveraged in a strategic sale, spend some time to work out how you can make it more valuable to the buyer and thereby increase your potential premium on sale.
Something would be worth more to a buyer if they could exploit it earlier and faster. Thus, if there were less issues to resolve post-acquisition, before the underlying asset or capability could be exploited, this would have a positive impact on the sale price.
A business that is well managed, efficient, with good governance and with few outstanding problems to resolve would clearly be more valuable. At the same time, a business that could be readily absorbed or integrated into the corporation’s organisation would be more attractive.
The major objective of the buyer is to exploit the opportunity. Where the underlying asset or capability has been structured so that it can be readily replicated or scaled, the opportunity can be more aggressively exploited. Where this results in higher growth revenue generation and earlier profits, the buyer generates an earlier payback on the acquisition investment. This in turn means that the investment has a higher present value and thus the seller has the opportunity of securing a higher premium on sale in a competitive bid.
When you have a specific buyer in your sights, you might spend some time working out how you can increase the strategic value of the assets and capabilities for that buyer. If the sales value to their customer has a certain price, what can you do to increase the price?
If your product has a number of features or components, can you add more to increase its revenue generating capability? If there is an after market for services, spare parts or complementary products, can you find additional services or products to add to the list?
If the product has an implementation or consulting requirement, can you increase the value of the revenue associated with that part of the sale? Your objective is to increase the revenue per unit and thus increase the revenue generating power of your offering.
The key to maximising the premium on sale with a strategic buyer is to confront them with a compelling opportunity to generate high levels of revenue and profits as soon as possible after the acquisition. The premium is, however, normally only secured by having multiple bidders after that opportunity.
This is especially effective if the revenue is either new revenue to all the bidders and provides them with a growth advantage or is a competitive weapon that will take market share away from the losing bidders.
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