Transitions: Setting a Value—The Never-Ending Quest

What’s my business worth? That question can dog a business owner for decades, but it’s never more vital to have an answer than it is as you prepare to transition out of your life’s work. But even before there was a global pandemic to throw a wrench into a high-performing M&A market, there were still plenty of hurdles facing the average business owner who has been anticipating an exit.

“Buyers are really buying future revenue streams, and with the uncertainty on the revenue side of things, what we’ve seen are more critical valuations of who’s assuming that revenue-fluctuation risk.” ­— Sam Scott, Sunrise Advisors

Some of those wounds are self-inflicted by owners who fail to do their homework and refuse to consider how their business is different than those not just in other sectors, but in their same line. Some are matters of timing, where an owner hasn’t left sufficient runway to tie up the loose ends that present red flags for buyers. Some are caused by waiting until you’re too close to retirement age—even past it—to start the process. And some, as we’ve seen in 2020, are black-swan events that no one could have anticipated, even at the start of the year.

The current pandemic fits into that category.


There’s no doubt about it, says Steve York of Stern Brothers Valuation Services: “The Covid-19 virus has increased the risk associated with estimating future cash flows for an investor in a business.”

Even for businesses that are experiencing booming revenues, he says, there is concern over supply constraints that restrict the ability to meet demand, or that demand will fall short as people realize they don’t need a year’s supply of whatever product they have stockpiled. And businesses that had to close, he said, “will face concerns that they will not have the resources to re-open, or that the facilities they are using will be sold or rented to a business that weathered the pandemic more successfully and took over their former space.”

In each case, he said, excelling or falling short, they are all in the same boat with the talent gap.

“This talent squeeze may ease as employment grows,” York said, “but for now, qualified labor is still in short supply.”

Kyle Danner, who has his own Overland Park-based consulting business for families, said that line of work effectively came to a stop in mid-March, with government edicts restricting business, including his speaking engagements. In that sense, he’s personally feeling the same pain his clients feel.

Overall, he said, “if a deal was in progress for a company that had good fundamentals, “that’s still moving along. For a lot of folks, things are on pause. Everybody is still afraid of catching the virus, and there is a lot of concern there, people expecting a second wave to hit.” But in succession terms, he said, some genuine horror stories are emerging.

“With the Baby Boomers, some have 70 to 90 percent of their wealth tied up in the business, and that was going to be their retirement nest egg. But some have seen a 10 to 60 percent loss in valuation, and some have already completely disappeared. Then what money they have in the market is also talking a hit. This has thrown everybody’s timeline in the air.”

Mike Anderson, managing director for Bridgepoint Investment Banking, said his firm went in Friday, March 6, working a deal that had 12 prospective buyers for a company, with face-to-face management meetings completed for all. “On Monday, the 9th, only two companies were still interested,” he said. “The vast majority were private equity, with a couple of strategic buyers.”

The private equity firms had nothing to gain by closing a deal too soon, he said, but one came through with a top-dollar offer and stood behind it even when it was clear they could have used the crisis to leverage a reduction. But, Anderson said, some industries absolutely went into the toilet. Before COVID-19 hit, more than $1 trillion in private-equity capital nationwide was being readied for deployment in a frantic search for acquisitions. “That money is still there, largely, but many firms called time out.”

Sam Scott, president and CEO of Sunrise Advisors, noted that with any deal “buyers are really buying future revenue streams, and with the uncertainty on the revenue side of things, what we’ve seen are more critical valuations of who’s assuming that revenue-fluctuation risk.” That has played out in the way payments are being structured to sellers. “It’s a constant battle between buyers and sellers of offloading risks,” Scott said.

The Basic Steps

Pandemic or no pandemic, owners hoping to sell this year or next need to be following a success playbook that will help yield the greatest value for their firms. That starts with some fundamentals. “Business owners must clean up their financial statements,” said York. “Start by identifying what costs are being covered by the business that would not continue if another investor owned the company. This may include memberships, a car, a vacation home, an airplane, family members on the payroll for benefit coverage, or other such expenses.”

Next, he said, prepare a cash-flow statement that would explain what the investor can expect, and back it up with historical results, adjusted to take out costs the current ownership has charged that would not continue under new ownership. Finally, identify key customers and determine how the sellers can ensure those customers would stay with the company under new ownership. All of that is going to require a time investment and an investment of cash to finance each move.

Lacking either, York said, an owner “should consider identifying significant assets of the company that can be offered for sale. Competitors may bid on things like customer lists, inventory (particularly now during the pandemic), technical know-how, talented and trained work force, and the trade name.” 

A sale of assets may seem like a forced liquidation, he said, but it also may be the best way to successfully realize value in a time of great uncertainty. “During distressed times,” he said, “there is a demand for struggling companies, if for no other reason than to eliminate competition with the stronger players in a market or industry.”

More than having financials reviewed, Anderson said, “if they would have their financials audited, that’s a huge plus. It saves a ton of time and a lot of potential headaches.” Just as important, though, where valuation is concerned, every owner “should, be able to provide me 3-5 years of clean financials that show a trend up.” There’s not much one can do about a trend down, though. It will take its toll.

A final step, he suggested, is ensure that client and vendor contracts aren’t just current, but readily available. And they should understand the nuances behind all of those documents; “No offense to a lot of owners,“ he said, “but I talk to guys running $20-to $40 million businesses who don’t know what EBIDTA is.”

Classic Mistakes

Perhaps the greatest mistake an owner makes in assessing the worth of his business is failing to understand economic conditions both inside his industry sector and outside of it. Too often, professionals say, owners are working on the misguided assumption that they will get a multiple for their manufacturing company that rivals what Fred Down the Street got for selling his law firm. Ryan Sprott of Great Range Capital cautioned against using figures from media reports about transactions and trying to apply those to your own company.

“For smaller businesses, there are not great M&A comps out there,” he said. “If your company has revenues of $20 million in a specific sector, it’s hard to figure out what others of that size might sell for, because there might not have been as many transactions.” On top of that, comparable sales figures for a private company are rarely available for review.

“Owners will often rely on trade association newsletters or meetings for information on sales of companies in their industry,” York said. “This is often like looking up how to cure cancer on the Internet; there are lots of opinions, but very few facts, and the facts that are found are not applicable to your company.”

When buyers consider an acquisition, he said, “they will always adjust the earnings of the target company based on how the buyer will run the company. The expected valuation multiples are only earned after cleaning up the financials, and eliminating costs as the investor will do once the company has been sold.”

One of the classic mistakes Mike Anderson sees is the failure to secure a neutral, third-party valuation. Others include going into a deal with too great a client concentration, lack of long-term contracts, and even basic industry trends. It’s also important for owners of smaller firms to understand that “I can’t get the same valuation for a company at $7 million EBIDTA as I can for the guy at $70 million.”

A key mistake, said Danner, was going into any discussion believing that your child is the best-looking and smartest in the classroom. What buyers really look at, he said, are weaknesses of concentration. “They are too dependent on the owner, who knows everything and maintains all key relationships,” Danner said, foremost. “They may have a key sales rep generating 60 percent of business, and that’s an exposure; they have a customer concentration with more than 20 percent in any one customer/market; or they have a vendor concentration, so think about the supply chain issues. Think about what happens now with a major disruption.”

On top of that, he said, if it’s an aging business where the owners failed to reinvest, it can create a domino effect in combination with the concentration of weaknesses. “When looking at a company valuation, the tangible assets are only a small piece,” Danner said. “It’s the quality of the leadership team, what the customer base looks like, do you have processes in place and documented, do you have your IP protected? Is all your equipment running? And what’s the social reputation of the company? Owners a lot of times overlook those because they are intangible—it’s harder to tie the ROI to those.”

Perhaps one of the most meaningful aspects of valuation isn’t within the business itself, but the ability to think of it as a piece of an owner’s overall life plan and wealth-management strategy: It’s a look to get you where you want to go after you’re done building it.

“The most value that can be added to the small business owner, the most value and best advice you give, comes at the intersection of personal planning strategies and business-planning strategies,” he said. “Those don’t often get equal attention. Sometimes, you have your head down in business, neglecting the personal side to the equation. You have to evaluate how those pieces work together—it’s the most important consideration people can make.”