Business valuation: get printers together and ask them how they value a business and you will find many methods. Problem is, as Zig Ziglar says, it’s “stinking thinking.” That’s because we don’t get to make the rules about how our businesses are valued.
No, bankers make the rules or, more broadly, the financial community based on principles of finance.
Why them and not us? They have the money to loan to the buyers of our businesses. So, regardless of how we view it; bankers are going to put their money where they choose and so it’s their rules that matter, not ours.
It goes back to the rule about the guy who has the gold rules.
So, it is in our best interest to know how values are determined. Knowing that, we have a shot at improving our performance before we put the business up for sale.
Of course, you don’t have to. One influential printer declares he doesn’t like the EBITDA method of valuation (Earnings before Interest, Taxes and Depreciation)? Fine, you don’t have to care for it either as long as your buyer is willing to give you cash. If they go to a bank, well, it would be helpful to know something about it.
There are two main methods of business valuation.
Best business valuation method is based on earnings. Simple example is the bank account. Work backwards. For simplicity, assume interest of 10% is being paid (we wish) and you earn $100,000 a year. What’s the bank account worth? Well, $100,000 / 0.10 = $1,000,000.
Don’t get excited though. Active investments (running a business) are always discounted when compared to passive investments (bank accounts).
In my experience, an active investment would be worth somewhere between 25% and 50% of the passive investment depending on the probability of maintaining earnings. That’s why it’s important to be increasing your sales and earnings to maximize value. If you’re not, depending on your time horizon, you may have time to fix it. If you don’t, not all is lost; it’s just that you’ll receive a lower value.
What I’m describing here is a capitalization of earnings method for business valuation. There are more such as a multiple of EBITA (which is why we want to know about it) a multiple of cash flow or some sort of multiple of earnings.
Which should you use? All of them.
The other method is valuing a business in parts.
That’s mainly assigning values to equipment, inventory, customer list and so forth to arrive at a total value or selling price.
Businesses without significant earnings or with no earnings are typically valued this way.
Between the two, values based on earnings always will be higher than parts in my experience.
We’ll do a deep dive into valuation methods in future editions. For now, just understand that printers don’t get to determine how businesses are valued. Oh yes, we may come up with a logic behind our values and that’s fine. Just don’t expect someone else to use that method. They’ll use financial methods similar to the bankers for it’s their money they are putting into the deal.
It’s great that your business has plenty of potential for earnings and growth. That will influence a buyer in whether to buy or not. Just don’t expect to get paid for it.
Your business should sell mainly on earnings. If you tell Uncle Sam it’s an expense, then most buyers will believe it’s an expense. “Oh yeah butta …..” You know, yeah butta I paid for things through the business that the next owner won’t have to pay so I should get a higher price. Hum.
There is a procedure called “normalization” in which some expenses are removed in order to identify “real” earnings of the business. Some common “allowable” expenses are travel, entertainment, trade shows, conventions, medical insurance for you and family, expensive cars through business, club memberships, subscriptions, continuing education and some salaries and bonuses to family members. However, this is up to the judgment of the buyer. A more reliable way is to show the income on the tax returns and pay taxes on them so if you’re within three to five years of selling; consider eliminating unnecessary expenses.
Dr. Leon Danco Passes: was sorry to learn of the passing of Dr. Leon Danco, the father of family business consulting, in February near Cleveland. I’ve written of him in a positive way numerous times. At dinner at his favorite Mayfield Country Club, he presented a toast to me, “Tom, a man is known by his disciples … don’t screw this up.” Will never forget that one and always will try to live up to it.
Questions and Comments:
Question: Did I see somewhere that your company does business valuations? If you do, we would be interested in having one done for our business. What are your fees?
Answer: Yes we do an “estimate of value” for print shops which costs $1,950. We develop a value range as well as specific value based on financial methods. The difference between what we do and a full-business valuation is that ours does not involve an onsite visit, nor is it as detailed and therefore not as useful in a contentious transition or a legal action such as divorce or IRS dispute. Here you need someone to not only provide a detailed valuation, but who also would support it through testimony in court. Of course, these types of full valuations run more – typically $8-$12,000 in many cases.
Our estimates of value are most useful for retirement planning as well as internal transitions such as selling to a son/daughter or employee. So it depends on the level of detail and support you need. Message me if you have an interest at email@example.com
In the meantime, here’s hoping that all your trails will be happy ones.