market update

Business Value vs. Price vs. Seller Proceeds

Business owners sometimes mix up the concepts of value and price, and have trouble relating these two different concepts to what they’ll get out of a sale of the business. Price and value are two different things, and business sale proceeds represent an entirely different thing. Owners, appraisers and brokers are often talking past each other with each one thinking the other understands, but there is actually a lot of misunderstanding. Appraisers prepare big thick reports about all the methods they used to calculate “fair market value” but does this have anything to do with what the seller pockets in a transaction? Well, yes, it has something to do with it, but it is by no means definitive. Does the “value” that the broker quotes for you have anything to do with what you’ll pocket? It might if you’re dealing with a broker who puts a price on your business like he was selling a house. Name a price and no-one will ever pay more. If you want to put the most money in your pocket you need a confidential, competitive process that brings multiple buyers into the picture. Each buyer will have different perception of value and one of these buyers will pay the most – that becomes the price. Stick with a single buyer, and you are unlikely to get the highest price.

Here are the factors to consider when you’re seriously thinking about a deal to sell a company or a deal to take some money off the table. How is the buyer looking at this? [Note: This analysis is for middle market companies, not for “main street” companies where different valuation approaches and deal structures are typically used. Call me if you have questions on this.]

Enterprise Value – the debt free, cash free value of an adequately capitalized “stand-alone” company (including sufficient working capital and all the operating equipment needed to operate it). That’s where the buyer starts the evaluation process. This may have something to do with the “fair market value” that an appraiser would calculate, but buyers aren’t appraisers and don’t really care about the theoretical constructs used in the appraisal world. They only care about what an acquisition is worth to them. The enterprise value for a buyer is based on two principal variables:

Free Cash Flow: generally approximated by EBITDA minus routine capital expenditures. (EBITDA = earnings before interest, income taxes, depreciation and amortization.)

Growth Rate: generally growth in EBITDA is more important than growth in revenue, but people do pay attention to revenue growth. Doubling revenue is only valuable if EBITDA is growing too.

Balance sheet – Cash and debt affect your proceeds.

Cash: “Excess cash” is kept by the seller. What’s excess? Anything over and above the working capital needs of the company to keep operating. As long as the business has enough inventory and enough accounts receivable, the seller should keep most or all of the cash. (Sometimes a small amount of operating cash needs to be kept in the bank accounts to keep the company in operation on day 1 after the closing.) So cash adds to the seller proceeds.

Debt: All the company’s debt is typically a subtraction from seller proceeds. Either the seller keeps the debt and pays it off from proceeds, or the buyer assumes the debt and reduces the price to account for taking over the debt.

Roughly speaking here’s what the formula looks like:

Seller Proceeds = Enterprise Value + Cash – Debt

That’s what to expect in a private equity deal.

But what if you orchestrate a competitive sale process with a number of strategic buyers? You may get some additional credit for the strategic benefits your company contributes to the buyer, i.e. you may get a higher price to start with.

Seller Proceeds = Enterprise Value + Strategic Value + Cash – Debt

I hope this helps you get a handle on the concepts and the likely results of a deal to sell your business or take some money off the table in a re-capitalization. If you want to know more, contact us via our web form or give our ACT professionals a call at 866-744-5422.

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