A Reasonable Price for Private Companies
Putting a price on privately-held companies is more complicated than placing a value or price on a publicly-held one. For one thing, many privately-held businesses do not have audited financial statements; these statements are very expensive and not required. Public companies also have to reveal a lot more about their financial issues and other information than the privately-held ones. This makes digging out information for a privately-held company difficult for a prospective purchaser. So, a seller should gather as much information as possible, and have their accountant put the numbers in a usable format if they are not already.
Another expert has said that when the seller of a privately-held company decides to sell, there are four estimates of price or value:
- A value placed on the company by an outside appraiser or expert. This can be either formal or informal.
- The seller’s “wish price.” This is the price the seller would really like to receive – best case scenario.
- The “go-to-market price” or the actual asking price.
- And, last but not least, the “won’t accept less than this price” set by the seller.
The selling price is usually somewhere between the asking price and the bottom-dollar price set by the seller. However, sometimes it is less than all four estimates mentioned above. The ultimate selling price is set by the marketplace, which is usually governed by how badly the seller wants to sell and how badly the buyer wants to buy.
What can a buyer review in assessing the price he or she is willing to pay? The seller should have answers available for all of the pertinent items on the following checklist. The more favorable each item is, the higher the price.
- Stability of Market
- Stability of Historical Earnings
- Cost Savings Post-Purchase
- Minimal Capital Expenditures Required
- Minimal Competitive Threats
- Minimal Alternative Technologies
- Reasonable Market
- Large Market Potential
- Reasonable Existing Market Position
- Solid Distribution Network
- Buyer/Seller Synergy
- Owner or Top Management Willing to Remain
- Product Diversity
- Broad Customer Base
- Non-dependency on Few Suppliers
There may be some additional factors to consider, but this is the type of analysis a buyer should perform. The better the answers to the above benchmarks, the more likely it is that a seller will receive a price between the market value and the “wish” price.
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Read MoreWhy Buy a Franchise?
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- Risk minimized. A reputable franchise is a proven business method. They’ve been through the ups and downs and know what works and what doesn’t work. That keeps the new business owner from repeating the same mistakes.
- Name recognition. A well-known name can bring customers into the business and provide a competitive advantage for the franchisee.
- Training. A franchisor can provide a regimented training program to teach the franchisee about the business operation and industry even if the franchisee has no prior experience. Training is usually done at the office of the franchisor and at the local location.
- Support. A franchisor can provide managerial support, software support and problem-solving capabilities for its franchisees. This support is there during the start up phase, but also continues for the term of the franchise; usually 10 or 20 years.
- Economies of scale. Cost savings on inventory items can be passed on to the franchisee from bulk purchase orders made by the franchisor.
- Advertising. Cooperative advertising programs can provide national exposure at an affordable price.
- Financing. A franchisor will generally assist the franchisee in obtaining financing for the franchise. Lenders are more inclined to provide financing to franchises because they are less risky than businesses started from scratch. In fact, the SBA keeps a list of the “approved franchises.”
- Site selection. Most franchises will assist the franchisee in selecting a site for the new franchise location. Having the right location is all powerful and most franchises have a connection to a local real estate professional to assist in site selection.
- Vested Interest / Royalty. Most franchises charge a royalty. This fee, charged for the use of the name and the ongoing support given to the franchisee, is usually around 5% of the franchisee’s sales. In other words, for every dollar the franchisee makes, the franchisor gets a nickel. This gives the franchisor a direct interest in the success of the franchisee. The more successful the franchisee, the more successful the franchisor. In simple terms, the more money the franchisee makes; the more money the franchisor makes. Thus, the commonly heard phrase; “In business FOR yourself, but not BY yourself”.
Who Is the Buyer?
Buyers buy a business for many of the same reasons that sellers sell businesses. It is important that the buyer is as serious as the seller when it comes time to purchase a business. If the buyer is not serious, the sale will never close. Here are just a few of the reasons that buyers buy businesses:
- Laid-off, fired, being transferred (or about to be any of them)
- Early retirement (forced or not)
- Job dissatisfaction
- Desire for more control over their lives
- Desire to do their own thing
A Buyer Profile
Here is a look at the make-up of the average individual buyer looking to replace a lost job or wanting to get out of an uncomfortable job situation. The chances are he is a male (however, more and more women are going into business for themselves, so this is rapidly changing). Almost 50 percent will have less than $100,000 in which to invest in the purchase of a business. In many cases the funds, or part of them, will come from personal savings followed by financial assistance from family members. The buyer will never have owned a business before, and most likely will buy a business he or she had never considered until being introduced to it.
Their primary reason for going into business is to get out of their present situation, be it unemployment or job disagreement (or discouragement). Prospective buyers want to do their own thing, be in charge of their own destiny, and they don’t want to work for anyone. Money is important, but it’s not at the top of the list, in fact, it probably is in fourth or fifth place in the overall list. In order to pursue the dream of owning one’s own business, buyers must be able to make that “leap of faith” necessary to take the risk of purchasing and operating their own business.
Buyers who want to go into business strictly for the money usually are not realistic buyers for small businesses. Keep in mind the following traits of a willing buyer:
- The desire to buy a business
- The need and urgency to buy a business
- The financial resources
- The ability to make his or her own decisions
- Reasonable expectations of what business ownership can do for him or her
What Do Buyers Want to Know?
This may be a bit premature since you may not have decided to sell, but it may help in your decision-making process to understand not only who the buyer is, but also what he or she will want to know in order to buy your business. Here are some questions that you might be asked and should be prepared to answer:
- How much money is required to buy the business?
- What is the annual increase in sales?
- How much is the inventory?
- What is the debt?
- Will the seller train and stay on for awhile?
- What makes the business different/special/unique?
- What further defines the product or service? Bid work? Repeat business?
- What can be done to grow the business?
- What can the buyer do to add value?
- What is the profit picture in bad times as well as good?
How Earn-Outs Impact the Sale of a Business
Earn-Outs and how they impact the sale of a business
By Matt Slappey CBI, BCI
Certified Business Intermediary; Mergers and Acquisitions (M&A) Advisor
Former GABB President Matt Slappey gave a presentation on earn-outs, what they are and how they can be used in the sale of a business. For those who missed this valuable presentation, the GABB gives you access to a recording of the speech and an outline of his PowerPoint presentation.
Earn-Out PowerPoint Presentation for the GABB
Earn-out:
Definition according to Google:
A provision written into some financial transactions whereby the seller of a business will receive additional payments based on the future performance of the business sold
Wikipedia defines it as:
Earn out refers to a pricing structure in mergers and acquisitions where the sellers must “earn” part of the purchase price based on the performance of the business following the acquisition. In an earn out, part of the purchase price is paid after closing based on the target company achieving certain financial goals
Reality of an Earn-out
- An earn-out is used in most cases to bridge what a seller thinks his/her company is worth to the price that a buyer is putting on that same business.
- When a business is full of “potential” that the owner has never actually realized (some of this is real and some is smoke)
- Keeps negotiations alive when the parties seem far apart.
Scenario
- You have a listing/engagement with a client.
- The client has $500K per year in cash flow.
- The market will tell you that a buyer’s offer of 3 x cash flow is not unreasonable.
- The seller wants $2,000,000+ or a 4x+ multiple
Things to understand
- Why does the seller think the company is worth more than the market rate?
- Is there a valid reason that the company is worth more?
- Is there true “unrealized potential”?
- Is the company about to land a large contract or opportunity?
Examples of Companies that lean towards an “earn out.”
- Consulting companies
- No sales reps other than the owner
- No management other than the owner
- Family members involved in the business
- Professional practices
SBA Deal?
- If you are going to seek financing via an SBA loan for your deal, do not pursue an earn-out because the SBA does not allow the use of earn-outs. They require a defined purchase price.
- This is not the SBA lenders in the room making the rule, it is the SBA.
Earn-out Structure
- Create an earn-out that is the most simple and effective way to measure company or owner performance.
- Complicated earn-outs must be clearly understood by all parties and all parties must be able to verify all the information required to create the payouts
Types of Structures
- Revenue Goal
- Gross Profit Goal
- EBITDA or SDE Goal
- Retention of current clients
- Acquisition of new clients
Tax Implications
- Most earn-outs are treated as an “Installment Payment” which allows taxation in the year it is actually received.
- Can use this technique to keep taxation of sales of smaller businesses under the top tax rates.
- It should also be noted that there may be situations in which a seller would choose to recognize the sale of a business currently and forego deferral treatment, such as when a business is sold at a loss, or when it is known or expected that tax rates will increase in the future.
Taking care of employees
It is possible for an owner to expense a portion of his earn out payments that are then paid to employees for retention or performance that leads to the seller receiving an earn-out payment. Scenarios change as to how to legally do this based on differences in an asset or stock deal, so consult a qualified attorney and/or tax advisor.
This can really motivate employees to achieve the earn out goals, thus earning it for the seller!
Summary:
Earn outs are a powerful tool to bridge the gap in business values.
Both sides can benefit from using them effectively.
There are tax implications and advantages of earn outs.
Knowing how to navigate earn-outs can help you close more transactions.
Questions?
Matt Slappey, 404-486-0350, mslappey@murphybusiness.com
www.murphybusiness.com/decatur
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GABB Affiliates Discuss How to Reduce Risk in a Transaction
Those who attended the August GABB meeting got to hear an excellent panel discussion of how brokers can reduce risk in a deal.
GABB President C. David Chambless moderated the panel of GABB Affiliates.
The panel included:
Dan Browning, JD, of DB Consulting, Inc., has 20 years of experience as a business appraisal professional and holds the Master Analyst in Financial Forensics (MAFF) and Accredited in Business Appraisal Review (ABAR) designations from the National Association of Certified Valuators and Analysts (NACVA).
David Cross, Senior Vice President-Wealth Management and Wealth Management Advisor with Merrill Lynch, is a specially qualified Portfolio Manager in the Merrill Lynch Person Investment Advisory® (PIA) Program, and can build and manage customized investment strategies and implement proprietary model portfolios, as well as provide traditional advice and guidance.
Larry Domenico, JD, is managing partner of Mozley, Finlayson & Loggins LLP, and practices extensively in the areas of products liability defense, commercial and business litigation, and general litigation; he has extensive experience in assisting start up and existing businesses, including estate planning for business owners, and alternate forms of dispute resolution including arbitration and mediation.
Chris Fonzi, founder and principal of Logic Environmental, Inc., has performed environmental assessments and provided consulting services in more than 20 states during the past 15 years. He is a graduate of the University of Florida and the UF School of Law.
Brian Harper is Senior Vice President, SBA Group at Atlantic Capital Bank and has 25 years of business banking and lending experience, and is a member of the Rotary Club of Dunwoody, Junior Achievement, Georgia Lender’s Quality Circle and the National Association of Government Guaranteed Lenders.
Sarah Wheeler, JD, a senior associate at Moore & Reese, primarily works with corporate transactions, community association law, real estate law (including foreclosures) and estate planning.
Guests are welcome to attend the GABB’s monthly meeting which starts 10:30 a.m. at the South Terraces Conference Center and is preceded at 9:45 a.m. by a free light breakfast and networking session. The GABB is the state’s largest professional organization dedicated to buying and selling businesses and franchises. The South Terraces Conference Center is at 115 Perimeter Center Place, Atlanta. For more information about the GABB, contact GABB President C. David Chambless at dchambless@abraxas.biz or 404-627-4454.
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