Key Takeaways:
- Engaging with a business valuation professional is critical for managing expectations and preparing the business to enhance its value, leading to a satisfying sale. The process starts with obtaining a business valuation, considering various value drivers like core business, management quality, customer base, competitive advantage, and market trends, with cash flow being paramount.
- In middle-market privately held businesses, valuation often uses market multiples derived from EBITDA, considering comparable sales of similar businesses. The valuation professional also examines unique business features, economic conditions, and potential for future cash flows to determine an accurate valuation range.
- Temporary variables like higher interest rates and economic conditions significantly impact business valuations. Sellers need to account for these factors and may need to make improvements or offer additional incentives to attract buyers.
Marketplace and Economic Influences Can Impact Valuation
Buying or selling a company can be a complex matter, influenced by factors such as unpredictable economic conditions or a seller’s expectations regarding the sale price. However, working with a valuation professional who can manage expectations and guide the preparation of the business to enhance its value can lead to a satisfying resolution for all parties involved.
A crucial first step in this process is obtaining a business valuation. This involves considering several value drivers.
Value Drivers
Elements such as the company’s core business, quality of management, customer base, competitive advantage, technologies, market share and industry growth trends are all factors that help drive a company’s value. These factors often influence the multiple applied to determine the selling price and the valuation methods used.
That being said, cash flow is paramount as a value driver. In the middle-market privately held business sector, buyers focus heavily on cash flow, and future cash flow projections are a critical component of the valuation.
Several methods are used in business valuations, but for the middle market, finding a relevant market multiple is particularly effective. The most commonly used enterprise multiple is derived from EBITDA (earnings before interest, taxes, depreciation, and amortization), a ratio that is an important indicator of a business’s overall profitability. Determining this multiple involves examining several factors, including comparable sales (comps) of other businesses in the target company’s industry.
A valuation professional will look at recent transactions involving similar businesses to determine comparable prices. They will also consider unique features of the business that could affect the multiple. Questions such as whether the industry or company is volatile, sensitive to economic fluctuations, or in optimal condition to demand a high multiple are evaluated. Once determined, the multiple becomes a critical data point in price negotiations.
In addition to the multiple, cash flow analysis is essential. It helps to accurately portray future cash flows and provides a picture of what the business will look like post-sale. However, it is not the only measure of a company’s value. Even a company with subpar cash flow can appear attractive if it excels in other areas.
Determining Valuation
Reaching a valuation requires a detailed analysis of the business’s financial performance, typically involving three to five years of financial data. This process includes normalizing the financials by removing non-recurring items, discretionary expenses, the owner’s salary, and extraordinary costs, such as those related to the COVID-19 pandemic. Once normalized, the valuation professional can run projections that will determine a valuation range.
Marketplace Influences
Temporary variable influences can significantly impact business valuations. Business owners considering selling need to account for the current business and economic climate before going to market.
In summary, selling a company involves careful consideration of both qualitative and quantitative factors, detailed financial analysis, and an understanding of the current economic environment. Working with a valuation professional can help navigate these complexities and achieve a successful sale.
If you are considering a business sale, contact your KRD advisor about a business valuation.
