Business Valuation 401 – Thinking about Your Business from a Buyer’s Perspective

Selling your business and/or want a professional, independent analysis of its financial performance and underlying valuation considerations? Excellent, as school is in session! Today we cover frequent questions about the valuation process as well as insight into how buyers will assess your business.      

In Business Valuation 101 we described how, why, and what we do to value your business. In previous posts we have also described early considerations when thinking about selling your business, 9 steps to take when you are ready to sell, and what to expect when selling your business. 

Across our team we complete anywhere from 2 to 10 valuations monthly. For context, examples of business types we have recently valued (figures reference revenue) include:

• $5M architecture and engineering services firm
• $17M web / ecommerce business
• $1.5M industrial cleaning franchise
• $28M electrical contractor for commercial and govt buildings
• $45M professional services firm
• $2M product concepting and design firm
• $6.5M countertop and stone business
• $13M brand and licensing business
• $9M uniform and trade apparel business
• $3M siding and niche construction business
• $2.5M moving and storage business
• $20M CPG brand selling via retail and ecommerce
• $11M restaurant group

There are almost always unique aspects with any business; this is one of the fun and interesting things about our work. However, regardless of the type of business, we follow a rigorous, methodical approach when completing a business valuation.

The valuation assessment process involves:

1. Analyzing financial documents, tax filings, and supplemental filings
2. Recasting Income Statements and Balance Sheet items as appropriate to arrive at the true economic benefit of ownership as well as accounting for non-operating, non-recurring expenses
3. Analyzing industry and transaction comparables for appropriateness. We review each transaction for relevance, a similar margin / profit profile, transaction structure, and exclude outlier transactions that could materially impact a data set
4. Reviewing other, unique considerations such as inventory, real estate, working capital requirements, mix of service / product revenue and profitability, industry outlook, and (if applicable) a calculation of loan support to arrive at financing capacity
5. Calculating a value range using a combination of revenue and profitability multiples

So what documents are needed? These include:

1. Income Statement (also referred to as a P&L or Profit & Loss statements) for 3 years and YTD 2021
2. Balance Sheet for 3 years
3. IRS filings and all supplemental schedules. 1120s, K1s, T2s – I will not say we have seen it all, but we are certainly well on our way there 😊 
4. Any internal sales reporting that details breakdown of revenue by product vs service, product line, channel, customer, market, etc. (need this by year)

At this point we break out our pencils and begin analyzing your financials. The valuation process is iterative, after reviewing financial statements (Income Statement and Balance Sheet) and IRS filings we work with you to get questions answered about the financials and better understand the operating model and any unique aspects (products, markets, customers, suppliers, value prop, etc.) of the business.  

Only after that conversation do we begin to look at DealStats, BizComps, the Business Reference Guide, and (if needed) consult our network of transaction / legal experts about any truly unique elements of a business that could impact a valuation range.  

How long does it take?  

For a market valuation assessment, we normally suggest a 2-week timeline, that said, we can often move quicker provided your documents are organized and you are responsive to questions about the financials and operating model. One reason for the 2-week timeline is that we have seller / owner clients we actively represent as well as other, in-progress valuation and advisory work.  

So, will you quote an industry multiple on an initial screening call?

No, and it is important you understand the context. In our 101 post I described why we never quote a multiple on an initial owner call. Instead, after we have analyzed financial statements and tax returns, recasted the P&L, and had a follow-up conversation with you to get questions answered about the financials and operating model – only then do we examine multiples within your industry. Our valuation range for your business will incorporate a combination of sales, gross profit, and earnings (EBITDA or SDE) multiples.

Using a combination of multiple approaches is critical – here is why:

Think about it..2 HVAC firms could both have $10M in revenue. The first has an average “ticket” or job order of $800 and competes in a competitive, residential market with high customer churn. On $10M in revenue it reports $450k in adjusted earnings. The second HVAC firm, also with $10M in revenue, has an average ticket of $5,100 with commercial / industrial firms accounting for 70% of revenue. Commercial accounts are stickier, less price sensitive, and more profitable. The adjusted EBITDA of this second HVAC firm is $1.6M. Using your go-to search engine that starts with a “G” and finding a sales multiple for an HVAC firm will simply miss the mark, potentially with disastrous consequences.

Historical performance and trends matter. A lot.

In addition to this mix of revenue, gross profit, and earnings multiples – we also evaluate the historical performance of a business and apply a weighting to each of the recent years. These weightings become quite important when a business is experiencing tremendous growth or encountering headwinds for one reason or another.

Remember, business owners need valuations and market comparables for a variety of reasons beyond selling their business, including for strategic planning and forecasting, buying out or bringing in a partner, to review eligibility for a commercial loan, private wealth & estate planning, divorce, etc.

At Washington Business Brokers we do a consistent volume of valuation preparation, advisory, and review for business owners. In fact, this is a great way for a business owner to “test out” a Business Broker. If you are interested in our valuation services, we do provide these as either a flat fee depending on the industry, complexity, and size of the business and/or bill on an hourly rate to provide input and considerations on a valuation that has already been prepared (examples here include partner disputes and divorce).

Our friend and Executive Coach in Portland, Michael Beck, had a great post about what can happen when will you wait till the last minute (or last 6 months) before consulting experts about your business value and future plans, check it out here. We rarely talk about the cost of inaction; checking in with your CPA and a deal professional can often yield substantial benefits and insight.

Another way of looking at this is always thinking out (ahead) 2 – 3 years. Those of you who follow our posts know we are active members and champions for the Washington Society of CPAs and International Business Broker Association. The sister organization to the IBBA, the Mergers & Acquisitions Source, has a well-written summary about a 2-year plan for owners.   

Now, some items buyers will be weighing as they evaluate your business:

Attractive market / industry. Is it clear there will be continued demand for your products or services? In your market?

Business / operating model. What does your revenue model and customer mix look like? How would a buyer grow the business and what resources would be needed to do so?  

Proven results. Stability – a track record of growth, durability of earnings and profits, and reputation go a long way with buyers.

Working systems. Often overlooked, but incredibly valuable to sophisticated buyers, are documented processes, scalable systems, using modern digital tools and marketing practices, etc.

Management and employees. Is the management team strong and committed to the business? What’s employee turnover look like?

Marketing, sales, & service. How are new customers acquired? Are these customers profitable? What marketing and sales levers are / aren’t working and what would a new owner want to consider?

I want to suggest a thought that I described in an earlier post, the concept of value vs. price. Remember:

Buyers are not buying the business you are selling – they are buying their version of the future.

You are selling the future potential of the business in the hands of the optimal buyer.

Want to read more on the valuation process and considerations? Here are several additional resources we recommend:

https://corporatefinanceinstitute.com/resources/knowledge/valuation/valuation-methods/

10 Things That Make Your Business More Valuable Than Others in the Same Industry – Maxima Divestitures Group

Selling a Business Checklist – Small Business Trends (smallbiztrends.com)

Each of these articles has excellent points, they are all worth exploring should you wish to learn more. 

Hopefully we have shed some light on the valuation process and how buyers will assess your business.

That is it for today – more to come in a future post. Please forward or share this content if you find it valuable. As always, thank you for reading! 

At Washington Business Brokers we are experts in valuation, optimizing a business for sale, buyer identification and qualification, negotiation, deal structuring, and closing. Our strategic advisor, Glen Cooper, has sold 500+ businesses in his career and is a nationally recognized author and trainer in selling private businesses.

We do not sell you on selling your business or buying one. Instead, we listen, provide options and expertise, and ultimately partner with you to accomplish your goals.

If you would like to better understand the value of your business or learn more about the process of confidentially selling:

call or text 937.344.8750
email [email protected]
or schedule time for an exploratory, free chat here