Speaking of Business: Business valuation means future view

Q: Both my son and an employee of mine want to buy my business. I would like to turn the company over to my son, but he feels I have been running the company badly, and therefore, wants to pay less for the company. Our sales exceed $7,000,000 annually. With this at stake, I question to whom I should sell the company? How should I value the company? What should I watch out for?

A: There are no easy solutions to your dilemma. No matter what you decide to do, there is the risk that you and your son will always be at odds about the final deal and the philosophy guiding the future of your business.

First, you must consider the nature of the process that affects both the buyer and seller whenever a merger, acquisition or divestiture occurs. I recommend you focus on three areas: perceptions of the future, forecasting the future and an overview of valuation.

When buyers and sellers come to the table to negotiate a deal, they each have different goals and different perceptions of the future. If buyers believe there is significant risk, they will want to spend as little money as possible to minimize the chance of not recouping the investment.

At the same time, if the buyers’ perception of risk is low, expert buyers will see the likelihood of recouping the investment in the future to be good. Thus, they have a high willingness to part with money now to gain a large return. Clearly, from a seller’s point of view, there is a need to find buyers who have confidence and experience. They will see less risk in a transaction and increase their bid.

Sellers must also look into the future. The sellers’ decision to sell is usually based on a desire to cash out. In essence, sellers borrow on future earnings and want as much of that future as possible.

If the sellers’ perception of the future is rosy, and if they want to continue working into the future; then they will hold out for a high price and continue to take wages from the business. However, if the perception of the future is not so good, or if the sellers want to get out as soon as possible; then they will lower the offering price to move the business quickly. In short, finding the right buyer can make all the difference in the world when selling a business.

Next, I recommend focusing on forecasting the future. Ask yourself the following questions:

” Where will your markets be in one, three or five years? Consider that your original markets might move away.

” Will the new buyer want to pay you for a task you will not perform?

” Can your products hold their price? This must be evaluated even if your markets are secure.

” Can your business remain cost-efficient? Will either your direct costs of doing business or your overhead remain in control?

“n What will the variables do down the road? Your assessments will determine how much someone is willing to pay, and how much you are willing to accept.

Finally, you need to consider the valuation. When doing so, the key concept to remember is you are asking someone to invest in a business with the prospect of earning a suitable return on his or her investment, given the risk involved. In doing your homework on valuations, you could read the vast array of printed material available and/or you could do the following:

” Approach a finance professor from the local college who will be objective. Offer to pay him or her a consulting fee to go over some basics of finance.

” Ask your lawyer, accountant and banker for names of people who are in the merger and acquisition business. Get references. Get to know these people. Rely on their expertise if you develop trust for their professionalism.

” Ask your accountant for a tax analysis of various selling scenarios.

The bottom line is that many popular valuation techniques are shortcuts and do not take into consideration the unique characteristics of a small, local firm. Remember that buyers are concerned with the initial outlay, and with the prospect of how much more cash they will need to inject during the coming years. Any future investments will offset the returns.

The investors, on the other hand, are interested in the cash that is generated by the operations of the business, which is why they will not look only at accounting earnings. With this knowledge, you can expect buyers to bid less than what you might think is an appropriate price.

You should recognize that negotiations will be long and tedious, taking up to 18 months. If you rush, mistakes will occur. Take time to do it right.

Greeley resident Russell Disberger is a founding member of Tekquity Ventures LLC, a Louisville-based specialty venture-capital firm investing in technology development and licensing. He can be reached at (303) 926-3990 or disberger@tekquity.com.

on Facebook on LinkedIn