Understanding Business Value – The First Crucial Step before a Sale

Many people would argue that the “market” is the best judge of a business’s value.  While true, it is not very helpful if business sellers or buyers go to market with unrealistic expectations.  Business sellers should never attempt to market their business to determine its value unless they intend to carry through with a sale.  Astute, serious buyers will quickly ascertain whether a seller is serious or simply testing the market.  It may impact the seller’s ability to effectively market the business in the future.

For sellers, having the business professionally appraised or alternatively, assessed/evaluated by an outside professional with deep industry-specific M&A experience, is an important first step. It is always possible that sellers will find a buyer that will pay an outsized multiple, or that buyers will find a below-market bargain, but it should never be assumed. 

There are many ways to estimate the enterprise value of a business based on its historical financials, asset values (costs to replace or build), projected cash flow/earnings, comparable analyses, precedent transactions, or some combination of each. All approaches have their advantages and disadvantages with the true market value influenced by the prevailing conditions both in the general economy and the specific industry vertical the business operates in.  There is no universally accepted best way to estimate the value of a private company in advance of a sale.

There are, however, a lot of resources that private company owners should think about utilizing before considering a sale.  Whatever valuation approach is used, it should be a prerequisite for any sale process or speculative dialogue with buyers.  Taking the time to have an outside professional assess the value of the business will provide owners with some important insights on what will drive its value in the future.  It is never as simple as growing the topline and bottom line, although growth is an important valuation driver.  Besides an estimate of the value of the business, owners should speak to professionals they trust with experience in their industry to ascertain the marketability of the business. Are there a small handful of buyers or would the business appeal to a wide range of financial and strategic buyers?  The broader the interest, the more likely a favourable outcome if selling for the highest price is the primary motivator.  Having an appreciation of enterprise value is even more critical when the buyer universe is limited.

A business appraisal by an accredited professional is often the best approach when there is a high percentage of the business value tied up in real estate and hard assets, in which the condition of those assets and their replacement value is crucial.  Commercial/Industrial real estate values are largely driven by local economic forces, so hiring an accredited appraiser with local knowledge and experience is advisable.
 
M&A advisors and Investment Banks are likely better at assessing the current market trends and valuation multiples in specific industry verticals they participate in and are more likely to have insider information on actual trading multiples based on their prior experience. While analytics, models, databases, and projections are important and helpful, experience, insight, and knowledge of the industry dynamics, the buyers’ strategies, and the underlying market trends will provide sellers with needed perspective in advance of a potential sale.
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Whatever approach sellers take, having a realistic view on the value of the business is a crucial first step, regardless if you want to broadly market the business through a traditional M&A sell-side process, or deal directly with potential buyers that would be a strategic fit.

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