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Factors That Influence Value
ALTHOUGH EVERY BUSINESS HAS ITS OWN UNIQUE SET OF CIRCUMSTANCES, BUYERS TYPICALLY EVALUATE POTENTIAL ACQUISITIONS IN A SIMILAR MANNER. BASED UPON CLEAR ROCK’S EXPERIENCE WITH TRANSACTIONS INVOLVING PRIVATELY HELD COMPANIES, THE FOLLOWING ARE THE MAJOR FACTORS CONSIDERED BY PROSPECTIVE ACQUIRERS WHEN DETERMINING A COMPANY’S WORTH:
Recast Earnings. With rare exception, a company’s recast pre-tax earnings influence value more than any other factor. Viewed in the simplest manner, buyers are looking to purchase a stream of income that will provide a desired return on investment and justify the purchase price. Consequently, most commonly accepted valuation methods primarily rely on multiples of earnings. It follows that the stronger the earnings the greater the value, all other factors remaining equal. Given this reality, it is critical that a seller present the financial statements in a format that will maximize the earnings in the eyes of the acquirer.
Fixed Assets. Tangible assets have a positive influence on value. Generally the greater the asset value included as part of a transaction, the greater the overall company value. However, since earnings typically have a greater impact on valuation than assets, increases and decreases in asset values rarely have a dollar-for-dollar impact on company valuations. Example: assuming there is equipment valued at $300,000 included in a transaction, increasing the amount of equipment to $400,000 may slightly elevate the company’s value but considerably less than the $100,000 difference. Large sums of required capital assets may actually be viewed as a “liability” to certain buyers as they require future investment to replace or maintain and diminish future available free cash flow.
Risk Factors. To determine a clear picture of a company’s value, buyers must weigh its future opportunities against the perceived business and economic risk. Elements of the business that increase risk decrease the value of the business. Conversely, elements that decrease risk increase value. Examples of risk factors that influence valuation include: Years in business; proprietary content, industry life cycle, industry stability, customer base concentrations or dependencies, supplier dependencies; product or service differentiation; strength and size of market; management quality and tenure; employee dependencies; impending regulation; new technology and many others.Although each of these risks is unique, they all have one common trait – an ability to either reassure or cast doubt on the predictability of future cash flow. As a result, the better a business can control, offset or properly present these potential risks, the more positive the impact on valuation.
Acquirer Identity. A company will have a significantly greater value to one acquirer than another. Much of the perceived value derives from the company’s strategic fit with a potential buyer. Strategic value can be achieved through cost synergies (i.e. elimination of duplicate expenses and reduction in cost of goods) or sales and marketing of complimentary products and services that afford new markets and customers to each company. The key is to identify potential acquirers that should have the most to gain from a business combination.
Terms. Price and terms tend to have a negative correlation. For example, an all cash transaction will generally yield a lower price when compared to a transaction that includes owner financing. The better the terms offered to a buyer, the higher the price that can be paid to the seller. This primarily relates to cash flow, the cost and availability of outside debt capital and the risk associated with completely “cashing out” the business owner at closing. The key is to identify the right combination of price and terms that creates a “win-win” for both buyer and seller.
Transaction Structure. Many other deal structure factors influence the total financial yield to a seller. Will the transaction be an asset sale or a stock sale? Will the seller receive continuing perks and fringe benefits? Will the seller retain certain assets (i.e. receivables, cash, deposits, etc.) rather than include them as part of the transaction? Will the seller be willing to structure an earn-out for a portion of the transaction? These and many other alternative transaction allocations and structures will have a direct impact on tax implications and total net yield to the seller.
Presentation and Packaging. When buyers evaluate a business opportunity, they expect the records and facts to be properly organized and documented. A professionally packaged business will greatly increase a buyer’s confidence and comfort level, thereby increasing the likelihood of a successful sale. Most buyers enlist their CPA, lawyer or business partners to assist in deal evaluation. These educational presentation packages keep everyone on the “same page”. You have spent years establishing name recognition, market niche, vendor relationships, operation and production systems, management, personnel, distribution channels, customer loyalty, expansion opportunities, synergies and numerous other intangible business assets. This is a story that needs to be properly presented to potential buyers. A professional intermediary can present the best possible picture of the entire business, thus maximizing the attractiveness and perceived value of the firm in the eyes of potential acquirers.