Beal Consultants works with both business buyers and sellers. We also do stand-alone business valuations. That allows us to have a unique perspective on the process of business valuations. Business buyers always want to get “a deal,” and business sellers always want “the best price.” In between these two opposite negotiating positions lies a fair price for all concerned.

Business valuations are determined by two key factors: The cash flow and the multiple.

The cash flow of the business is determined by the profit, plus or minus a number of “normalizing adjustments.” As a seller, you need to help identify various parts of your income statement that should be adjusted as we work with you to prepare your business for sale. Typical adjustments include owner’s compensation, depreciation, and other expenses that have a highly variable or somewhat discretionary component.

The multiple is even more important. This is conceptually similar to the “price-earnings” multiple that public companies trade at. However, there are key differences between private company and public company multiples due to a number of factors. Google recently traded in excess of 100x its current earnings. However, private company multiples are significantly lower due to tax issues, management issues, size, growth potential, and risk profiles. Typical private firms trade at 3-5 times their normalized cash flow.

Below are some definitions and considerations a seller should understand before trying to negotiate a “fair price.”

Definitions:

Fair Market Value

“Fair market value” can be defined as the highest price that a business interest would fetch in an open and unrestricted market between informed and prudent parties, acting at arm’s length, neither party being under any compulsion to buy or sell, calculated in financial terms.

However, the price you settle at can be significantly higher or lower than a theoretical “fair market value” due to the following issues:

1. Buyers and sellers rarely have access to the same information, finances, and negotiating abilities
2. There are emotional considerations for both the buyer and the seller. The buyer may be willing to pay a premium just to “buy a job.” The seller may be reluctant to sell for “fair market value” because the business may hold strong emotional attachments.
3. There may be legal and/or contractual restrictions that limit the flexibility of the vendor that hamper the realization of true value.
4. The buyer or the seller may be forced to act due to health or other concerns.
5. Value is calculated assuming a 100% cash sale. The terms may not be 100% cash, so adjustments would have to be made in price.

As a seller, always keep in mind that a business is worth what someone will pay for it, not what you think it is worth to you.

Other valuation terms useful to know:

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization

This is the starting point of most valuation and business analyses. However, you must be careful because, despite conventional wisdom, EBITDA may not equal cash flow. Make sure you understand what is included and excluded in any company’s analysis of the books.  

Normalized After Tax Cash Flow

This refers to the companies after tax income, appropriately normalized for various non-recurring expenses (or revenues). It gives you a picture of an “average” year’s results.

Seller’s Discretionary Cash Flow (SDCF)

SDCF is used to value smaller businesses, where the owner is a hands-on manager. Because “profit” and “Owner’s compensation” are driven more by tax considerations than real financial and market factors, this figure ignores the tax-driven arbitrary split between the two and looks at the total benefit to the owner.

Liquidation Value

Liquidation value is the value of assets if sold as assets rather than as a going concern.  It is typically assumed to be an orderly liquidation, as opposed to a fire sale.

Book Value

Value of the assets as recorded on the balance sheet, after depreciation. Equal to net book value. Underlying assumption is that financial statements are prepared using Canadian GAAP, which is on historical cost basis.

Replacement Value

The current cost of replacing an asset with a similar quality asset.

Intrinsic Value

The value of a business on a “stand-alone” basis, without consideration for a premium that may be paid by a synergistic acquirer. It is calculated based on the required rate of return investors and current operating performance of the company, with no assumption of synergies upon acquisition.

Net Realizable Value

Net proceeds after the sale of an asset, after providing all disposition costs, including income taxes.

Value to Owner

Value to owner measures the value of the company in the hands of the owner. This can differ from other types of valuation measures for a number of reasons:

1) Benefits of Ownership of a Business

• Emotional Benefits: The owner may have an emotional and or sentimental attachment to his business that would be impossible to value in monetary terms.
• Financial Benefits:  The value of the ability to determine salary, bonus, and benefit mix.

2) Operating Benefits (Financial)

• The owner may have specific knowledge, contacts or abilities that are not transferable, causing the business to have a greater value in his hands than in anyone else’s. This is referred to personal goodwill, and is typically non-transferable, and non-commercial.

3) Corporate Structure (Financial & Control)

• The owner may have different classes of voting and non-voting common or preferred shares that would have different value in the hands of the owner versus any other buyer.