Knowing the true market value of your business even before the business is officially for sale is essential. But to understand the complex issues behind business valuation, you need the trusted guidance of someone who knows how this process works.
In Valuing Your Business, Frederick Lipman a corporate attorney and former Wharton lecturer with more than forty years' experience in M&As, sales of companies, and IPOs reveals the proven strategies for managing valuation before selling a business.
This straightforward guide leads you through the entire process from beginning to end, addressing topics such as:
- How to enhance the value of a business
- Hidden costs and pitfalls to watch for and avoid
- Where to find expert attorneys and accountants
- Techniques for negotiating a deal that will maximize the sale price while avoiding unnecessary taxes
- Strategies for marketing a business to buyers without alarming staff, suppliers, competitors, and the media
- And much more.
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About the Author
FREDERICK D. LIPMAN is a partner with the law firm of Blank Rome LLP in Philadelphia. He was a lecturer in the MBA program at the Wharton School of Business. A graduate of Harvard Law School, Lipman has more than forty years' experience with M&As, sales of companies, and IPOs. In addition to his books, Lipman has appeared as a television commentator on CNN, CNBC, and Bloomberg, to name a few.
Read an Excerpt
Valuing Your Business
By Frederick Lipman
John Wiley & SonsISBN: 0-471-71454-2
Chapter OnePreliminary Considerations
Selling a business is a complicated, time-consuming, and at times, emotional experience. You should give consideration to all of the following factors before seriously embarking upon the sale process.
UNDERSTANDING YOUR MOTIVES
It is important that you understand your motivation for selling your business. Your motivation will dictate the nature of your buyer and the structure of your transaction.
For example, if you are no longer interested in operating your business, you do not want to sell to a financial buyer or to have an earnout. An earnout is a provision in the agreement of sale that would measure the purchase price in whole or in part by the future profits of the business.
A financial buyer will typically not have the management in place to run your business and will expect you to remain to operate the business under a long-term employment or consulting agreement. You would not want to agree to an earnout unless you are in control of the business because otherwise, your final purchase price could be significantly reduced by poor performance of the managers installed by the buyer.
Understanding your motives to sell your business also helps you avoid what is called "seller's remorse." In general, seller's remorse results from the significant change in lifestyle that the sale of your business can bring, together with theemotional attachments that you have toward the business. Truly understanding your motivation will help you get through a very natural period of doubt and uncertainty concerning the wisdom of selling your business.
The following are some typical reasons for selling, which are usually a mix of personal and business:
You are tired of working so hard and are ready to retire. You have no children who are interested in taking over the business. You have children who want to take over the business, but they are not competent to operate it. New competitors are moving into your business area, and you do not have the capital with which to fight them. You would like to have enough money in the bank so that you can support your lifestyle for the rest of your life. You need more capital resources than you can acquire to grow the business. Your business is going downhill, and you would prefer to sell it before it reaches the bottom. You were just divorced, and you retained the second-best lawyer in town. Unfortunately, your ex-spouse retained the best lawyer in town, and you owe your ex-spouse a huge amount of money. Your partner just died, and you do not have enough life insurance to buy out your partner's family as required by your shareholder agreement. You just died, and you did not maintain enough life insurance to pay death and inheritance taxes.
The preceding are only the major motivations; many other reasons may exist. At the beginning of the decision to sell your business, you may have one set of motivations and by the time the process is through, you may have dropped those motivations or added new ones.
What is important, however, is that you fully understand your motivations to sell your business and that you allow those motivations to continually guide the logic of your sale.
ASSEMBLING YOUR PROFESSIONAL TEAM
Your first step should be to assemble an outstanding professional team to advise you.
Most businesspersons select their professional team on the eve of their sale. This is far too late in the sale process. By selecting your professional team several years before the target date for your sale, you can obtain their guidance in the presale years as to methods of minimizing the obstacles. Your professional team will help implement the advance planning recommendations contained in Chapters 2 through 6.
The first person on your team should be an attorney specializing in mergers and acquisitions, an M&A attorney. This person might not be your regular attorney, who may be inexperienced in this area. You must carefully interview your attorney to learn about his or her expertise. Ask your attorney how many mergers and acquisitions he or she has handled in the last three years and what size businesses they were.
If a public company is a potential buyer, does your attorney have securities law experience? Has your attorney ever handled the sale to a public company where stock was part of the purchase price consideration?
If you do not get favorable answers from your personal attorney, look elsewhere. Most large corporate law firms maintain groups of attorneys who specialize in M&A. Select someone who not only is well experienced in M&A but also has good business sense and is someone with whom you have a good rapport.
The requirement that your attorney have good business sense cannot be overemphasized. You will need to make delicate trade-offs during negotiations, which require business and legal judgment from your lawyer. You need a lawyer who thinks like a businessperson but also has the necessary legal skills to protect you. It is a mistake to hire a lawyer who is a good scrivener but cannot properly translate legal risks into business risks and assist you in evaluating their importance.
During the sale negotiation, it is not unusual to instruct your attorney to play "bad cop" while you play "good cop." The good cop-bad cop negotiation strategy helps insulate you from the angry emotions of the buyer. This is particularly helpful if you expect to work for the buyer, but is also useful if you want to maintain a distance from the give-and-take of the bargaining. Be certain that your M&A attorney can play the bad cop role but also knows when to stop playing it.
Be wary of attorneys recommended to you by an investment banker or business broker involved in your sale. These attorneys may be experienced in M&A, but they also may feel beholden to the person who recommended them. Carefully interview such attorneys to determine if they are sufficiently independent that they could recommend that you terminate the investment banker or business broker or not proceed with an agreement of sale that is against your interests but would result in a fee to the recommending investment banker or business broker.
In addition to an M&A attorney, you will need a tax attorney. This is true even if you have a good tax accountant. Unless the tax consequences of your sale are simple (which you cannot know in advance of its structuring), you will want to double-check any tax advice you receive with a second tax professional. Tax attorneys and tax accountants sometimes approach tax issues differently, and you should solicit the views of both.
If your business is a C corporation for federal income tax purposes, one of the first questions to ask your tax consultant is what the tax consequences would be of changing to an S corporation. There are serious tax disadvantages to selling a C corporation, which are discussed in Chapter 11.
It is worthwhile to weigh the costs of changing to an S corporation five years prior to your sale target date versus staying a C corporation for the same five years and suffering the adverse tax consequences when you sell. This, of course, does not necessarily apply if you have a C corporation that is qualified under Section 1202 of the Internal Revenue Code, which is discussed more fully in Chapter 11 under the heading Fifty Percent Exclusion.
It is generally not necessary to select a new accountant in order to sell your business. Most accountants can perform this task.
Some business owners use their accountant to negotiate the business terms of the sale. Caution should be exercised in doing this. Inquire how many sales transactions your accountant has previously negotiated, as well as their size and complexity. Discreetly inquire from other clients of your accountant as to whether they were satisfied. You must be discreet, because you do not want to announce to the world your decision to sell your business.
Your accountant and your personal attorney may be losing a significant portion of their revenues if your business is sold. Be sensitive as to how important your fees are to them.
Investment Banker or Business Broker
As early as five years before your sale target date, you should consider obtaining advice from an investment banker or business broker. The advice should primarily cover the following areas:
an estimated value of your business as it currently exists and the factors that affect that value (see Chapter 2) the likely buyers for a business such as yours
You should seek this advice even if you intend to sell the business yourself and do not expect to retain an investment banker or business broker.
The purpose of this advice is to help guide you in the growth and development of the business during the years prior to the sale target date. If negative factors about your business are identified by the investment banker or business broker, you should take steps to eliminate them to the extent possible.
For example, if you are advised that you have a weak management team, you should consider strengthening your management structure during the years prior to sale. Likewise, if you are advised that your overdependence on a single customer will materially reduce your ultimate sale price, you can make efforts to diversify your customer base in the years prior to sale.
The investment banker or business broker you select as an advisor need not necessarily be the same one you choose to sell your business (see Chapter 6). You should select your investment banker or business broker based upon their familiarity with your industry and the quality of their advice.
Chapter TwoMaximizing the Sale Price
It is important to understand how your business will be valued in order to avoid setting either too low or too high a sale price. The following are methods of valuing your business, along with techniques to maximize that value.
UNDERSTANDING THE METHOD OF VALUING YOUR BUSINESS
You can increase the value of your business if you understand how buyers are likely to value it. Likewise, by understanding the valuation method, you may be able to remove assets from your business prior to sale that do not affect the valuation, thereby effectively increasing the total sale consideration you ultimately receive.
An appraisal of your business, which specifies the primary valuation methods and factors, should be sought from a qualified appraiser well in advance of the expected sale date. Such an appraisal could cost as little as $5,000 to $10,000. Select the appraiser by reputation and personal recommendation.
In general, an appraiser from an investment banker or business broker with actual experience in selling businesses in your industry is the most valuable. What is important is not so much an appraisal of what your business is currently worth but rather an understanding of the primary methods of valuation and valuation factors. Someone who actually sells businesses in your industry is best qualified to provide this information.
If you cannot find anyone with such experience, look for appraisers who are members of recognized appraisal groups that require an examination. The prestigious American Society of Appraisers and the somewhat newer Institute of Business Appraisers (typically, certified public accountants) are examples of such groups. The Institute of Business Appraisers does not require any specific valuation experience, in contrast to the more rigorous requirements for the American Society of Appraisers, which requires five years of experience for the designation accredited senior appraiser and two years for the accredited member designation.
These different professional requirements usually are reflected in the cost of the appraisal, with members of the American Society of Appraisers generally charging significantly higher fees.
Appraisal is an art, not a science. Take all appraisals with a large grain of salt. The larger your business, the less likely that the appraisal will be accurate in assessing your business' total valuation. Businesses that are worth more than $5 million to $10 million tend to attract financial as well as strategic buyers. The presence of financial buyers tends to drive up the price.
No one can accurately predict what you are worth to a particular strategic buyer. The strategic buyer may find that the value of your business to them far exceeds the result of any standard valuation formula. Your customer list, sales force, and market identification may blend so well with the market direction of the strategic buyer that a high sale price can result.
The balance of this section presents some of the more common methods used to evaluate a business.
Businesses worth less than $1 million tend to be valued using the rule-of-thumb formulas and the asset accumulation methodology, which are discussed in the sections that follow.
Buyers of businesses worth $5 million or more tend to use the Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) method combined with a comparable transaction analysis. If no significant earnings exist, a discounted cash flow methodology will be used. It is not unusual for the investment banker to also use a discounted cash flow analysis to double-check the valuations obtained using the EBITDA or comparable transaction method.
Caution should be exercised in using any formula to value your business. Every business is unique and thus, using only formulas can give you a very misleading picture of your value because they are not tailored to your particular business. There is no substitute for an appraisal performed by a competent investment banker or business broker.
However, even the best appraisal cannot take into account the value of your business to a specific buyer. For example, a strategic buyer who can lay off all of your back-office employees might be willing to pay an absurdly high price for your business because of the cost savings of the layoffs. Without knowing the pro forma effect of combining your business with the business of a specific buyer, any appraisal becomes little more than an educated guess.
Potential buyers have a variety of rule-of-thumb methods for valuing businesses, depending on the nature of the business. For example, vending machine businesses are typically valued based on the number of locations. Cable TV businesses are typically valued based on the number of subscribers. The accounting income shown by these businesses is only of secondary importance to the buyer, because the buyer will change the business to conform to the buyer's model, thereby making your financial results irrelevant.
Rule-of-thumb valuation methods are more typically used for smaller businesses (usually valued at less than $5 million), particularly where there is a perception that the financial information is not completely reliable. However, rule-of-thumb formulas are occasionally used for larger businesses as well.
If you are in a business that uses these rules of thumb (e.g., vending machine locations or cable TV subscribers), consider increasing your locations or subscribers prior to sale. Thus, by understanding the valuation method for your business, you can increase the likely sale price.
Some valuation experts have criticized this method of increasing valuation because it ignores profitability. They argue that a cable TV system, which is valued at $3,000 per subscriber, can easily add new subscribers by cutting prices or giving away free services. Adding new subscribers at a loss per subscriber should not, they argue, increase the value of the cable TV system.
Excerpted from Valuing Your Business by Frederick Lipman Excerpted by permission.
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Table of Contents
PART I Advance Planning
CHAPTER 1 PRELIMINARY CONSIDERATIONS 3
CHAPTER 2 MAXIMIZING THE SALE PRICE 9
CHAPTER 3 ELIMINATING DEAL KILLERS AND IMPEDIMENTS 31
CHAPTER 4 PROTECTING YOUR BUSINESS 38
CHAPTER 5 PERSONAL CONSIDERATIONS 45
CHAPTER 6 MARKETING YOUR BUSINESS 51
PART II Preliminary Negotiations
CHAPTER 7 SURVIVING THE BUYER’S DUE DILIGENCE 61
CHAPTER 8 AVOIDING NEGOTIATIONS TRAPS 68
CHAPTER 9 LETTERS OF INTENT: A RECIPE FOR LITIGATION 77
PART III The Sale Process
CHAPTER 10 STRUCTURING YOUR TRANSACTION 95
CHAPTER 11 THINK AFTER TAXES: CASH FLOW TO YOU 102
CHAPTER 12 SELLING TO A PUBLIC COMPANY 112
CHAPTER 13 SELLING A PUBLICLY HELD COMPANY OR A CONTROL BLOCK 118
CHAPTER 14 SELLING TO YOUR OWN EMPLOYEES OR TO AN ESOP 121
PART IV Sale Terms
CHAPTER 15 DEFERRED PURCHASE PRICE PAYMENTS: HOW TO BECOME THE BUYER’S BANKER 131
CHAPTER 16 EARNOUTS: ANOTHER LITIGATION RECIPE 138
CHAPTER 17 NEGOTIATING EMPLOYMENT AND CONSULTING AGREEMENTS 144
CHAPTER 18 AVOIDING TRAPS IN THE AGREEMENT OF SALE 149
PART V Alternatives to Selling Your Business
CHAPTER 19 LEVERAGED RECAPITALIZATION 173
CHAPTER 20 GOING PUBLIC 178
CHAPTER 21 VALUING INTERNET BUSINESS 189
PART VI Appendixes
1. SELECTED SALES OF BUSINESSES WITH SALE PRICES FROM $10 MILLION TO $1 BILLION 207
2. SELECTED SALES OF BUSINESSES WITH SALE PRICES FROM $1 MILLION TO $10 MILLION 219
3. SELECTED RECENT SALES OF BUSINESSES WITH SALE PRICES FROM $500,000 TO $1 MILLION 241
4. SAMPLE CONFIDENTIALITY AGREEMENT 264
5. SAMPLE STANDSTILL AGREEMENTS 268
6. SAMPLE LETTER OF INTENT 269
7. SAMPLE AGREEMENT TO SELL ASSETS FOR CASH 271
8. SAMPLE AGREEMENT AND PLAN OF MERGER 302