Selling a Business During the Recession

In my latest column for the Tennessean, I examine the opportunities and risks of selling a business during this recession:

There appears to be an increase in the number of entrepreneurs selling
their businesses over the past few months. Financially strong companies
and cash-rich investors looking for good acquisitions are starting to
move into the market.

Just having assets
such as buildings, land, equipment and even inventory is not what
creates value. Those assets must have the ability to continue to earn
profits for a new owner. It is the prospect of those future profits
that gives a business its real value.

The
simplest way to think about business value is this: People are buying
your business’s ability to generate future profits. Typically, the
value is based on a multiple of profits. Historically, valuations have
been about three to eight times annual operating cash profits (ignoring
things like depreciation, corporate taxes and interest expenses) with the most typical multiplier being about four.

If
a buyer offers a multiple of profits of four, and your business has
operating cash profits of $100,000, you can expect a valuation of about
$400,000.

Since
it is a buyer’s market right now, you need to set realistic
expectations going into any discussions about a sale of your business.
I am hearing that there has been about a one-point drop to a multiple
of three times profits.

What does that mean? Just like home values, your business’s value has dropped by about 25 percent, all things being equal.

But remember: The other part of the valuation equation is the profitability of the business.

How to prepare

Most
entrepreneurs have reported a significant drop in their profit margins
over the past year. So, that means that the drop in values could become
much greater than 20 percent or 25 percent if profits are also down. My
advice is as follows:

Understand
what drives the value of a business. What multiple you are likely to
get is based on your projected growth, the health of your industry, the
strength of your customer base projected into the future, and specific
strategic advantages that you may be able to offer the buyer.

Know your number. If you need a certain amount of money from your
business to retire, have that number in mind going in. If the market is
not supporting that value right now, you might want to wait until a
later time. Use that time to improve your profitability so that when
the economy picks up your operation will have an even greater value.

Seek expert advice. Work with your certified public accountant and
an attorney who specializes in mergers and acquisitions to understand
the process and to help set realistic expectations. This will be money
well spent.

Realize
that deals change. Once the buyer gets into due diligence, the price
may drop. Once they learn more about the business, they may lower their
projections for what they believe your business can earn for them in
the future.

Be
prepared for this, and know how much you are willing to go down ahead
of time. Be ready to walk away if the price they are willing to pay
drops too much.

Don’t
let your emotions lead you to take an overly discounted price — buyers
can smell desperation and will use that to their advantage by trying to
drive down the price during due diligence.

The
odds are that about one out of 50 inquiries about buying a business
will lead to an actual sale. Keep a level head and don’t even dream
about how you’ll spend all of that money until you get it in the bank.