What does a buyer need to know about your business?

To complete a purchase, a buyer must have an in-depth understanding of your business; particularly the risks and opportunities associated with it. Financial statements and other financial data are integral to this process. Beyond the financials, there is a need for information relative to insurance, legal, markets, products, and organization.

To protect both parties, the seller and prospective buyer begin the selling process by entering into a Non Disclosure Agreement. Under this agreement, the Seller provides adequate information to allow the buyer to formulate an offer. Commonly, the offer is in the form of a Letter of Intent. The non binding offer will have pricing and terms and allow buyer to perform additional due diligence prior to closing. What information is provided before as opposed to after an LOI is important but a separate discussion. Our point now is that before reaching a closing the seller will have disclosed a substantial amount of sensitive information. The level of due diligence increases when buyer is considering an equity purchase due to the potential liability assumed.

Adverse findings may affect the pricing or terms, or even the completion of a transaction. At times business opportunities are also uncovered.

When looking to sell your business, it is important to be prepared for the requirements of the due diligence process. They can seem onerous and disruptive. While the specifics of due diligence vary from company to company and industry to industry, here are typical items included:

1. Financial Statements

a. Audited Statements for a minimum of 3 years and often 5 years.

b. YTD Income Statement, Balance Sheet and Statement of Cash Flow

c. Quarterly or monthly detailed operating statements for up to 5 years by division or business segments

d. Accounts payable ageing detail and payment terms

e. Accounts receivable ageing detail, terms of sale, and write off history

f. Sales by customer

2. Fixed Assets

a. Schedules of Real and Personal Property including Depreciation

b. Depreciation and Capitalization Policies

3. Other Assets

a. Patents, Copyrights, Drawings, Other Intellectual Property, and intangible assets

b. Sales or Performance Contracts

c. Detail Inventory Report

d. Other agreements

4. Financing

a. Equipment, Auto, and Real Property leases

b. Bank or other borrowings with terms, rates, signers, guarantors, and collateral

5. Insurance

a. Schedule and copies of all insurance policies and bonds

6. Operations, Administrative and IT

a. Policies and procedures relative to cash and accounting controls

b. Policies and procedures relative to purchasing, proposals, sales, pricing, quality control, inventories, security, employee safety

c. Schedule of computer system equipment, software, apps, databases and support with underlying contracts and detail

d. Workman’s compensation rating and history

7. Business

a. Markets and Growth Outlook

b. Competitors and Market Share

c. Sellers Competitive Position by market, trade, product, practice area, and or division

8. Organization

a. Business Structure

i. Organizing documents: articles of incorporation or organization, by-laws, operating agreements for company and subsidiaries

ii. Divisions and Subsidiaries

iii. Officers, Directors and compensation of same

iv. Indemnification of Officers and Directors

v. Ownership Summary

vi. Related Party agreements, transactions and relationships

b. Management and Employees

i. Organizational chart with Management

ii. Schedule of personnel including title, function, compensation, job class, and responsibility, perhaps by division, or facility, or market

iii. Resumes of key personnel

iv. Employment contracts

v. Personnel policies, manuals, employee handbooks

vi. Union Contracts

vii. Medical Insurance

1. Contracts

2. Employee and Company Contributions

viii. Retirement plans

ix. Incentive Plans

x. Employee loans

xi. Any employee-company agreements

9. Legal

a. Past, current and potential lawsuits, arbitrations, regulatory/governmental investigations or actions along with potential or actual costs, liabilities, payouts and reserves, pleadings, briefs and any other documents

b. Agreements between Company and directors, shareholders, and officers

10. Environmental

a. Any environmental reports

b. Known or potential environmental issues

Author: Charles Lehnbeuter

©2019 Neubaden Group, LLC

#charleslehnbeuter

#sellingabusiness

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A business is worth what someone will pay for it ...and other thoughts on business valuation.

My crusty, German accountant father used to say, “A business is worth exactly what someone will pay for it.” This cautionary byline has proven to be true during my career. Valuations are useful but should be taken as guidelines not truth. When a transaction is done, you have the value.

That being said, there are many approaches to valuing a business. They would include price to sales, price to book, price to earnings, discounted cash flow and replacement cost. Each has its merits. If you would like to inquire further regarding these methods, please drop us a note at info@neubadengroup.com .

The simple fact is that most valuations in the lower mid market are done on a Multiple of Pre-Tax Cash Flow. The reasons are simple:

1. Cash is king. Ultimately, the buyer must recoup his cash investment (whether borrowed or out of his own pocket) while making an acceptable rate of return.

2. Pre-Tax Cash flow is simple to calculate. The information is readily available from a complete set of financial statements. Earnings before taxes plus interest plus depreciation and amortizations. It is the same for every buyer. Everyone understands what it means.

In reality, investment principal is paid back with after tax dollars but the tax rate varies from buyer to buyer. The calculation itself may be complex. As a result, after tax cash flow is not good for comparison purposes.

3. A multiple is also simple and easy to compare. It is a single point measure of risk and growth translated into a cost of capital. The math can be done in your head. A 4 multiple means a 25% pre-tax cost of capital. An EBITDA multiple serves a similar purpose as a cap rate in a real estate transaction.

4. Other methodologies are used as supplements. Many buyers will create a model of discounted cash flows to assist them in setting their price, particularly when rapid growth is involved. The model will have forecasts. Forecasts may or may not be accurate.

Buyers may also check their value against price to book and price to sales. Sometimes buyers will compare it against the cost of building the business from scratch.

What is the Multiple for my business?

Multiples vary widely from industry to industry and within a given industry. In the lower mid- market, most transactions occur between 4 and 6 times. Acquirers are often looking for 16% to 25% return on their investment. Some sources indicate that 5, or a 20% cost of capital, is the most common multiple. Your multiple will be within a range typical for your industry. Where you are in that range will be a function of the company itself.

What moves the Multiple? Fear and greed.

For instance, the larger the cash flow the higher the multiple. A company with $3 Million EBITDA will receive a lower multiple than a company doing the exact same thing with comparable margins and growth rates and $10 Million EBITDA. Less risk.

The higher the margins, the higher the multiple. If you are a low margin seller and pricing in the market weakens, you may be unable to operate. If your margins are higher you have more room to maneuver; less risk.

The higher the growth, the higher the multiple. If buying $3 Million in cash flow today can lead to $4 Million in cash flow next year, and then $5 Million and so on, buyers will pay more than if the $3 Million is flat. This is greed and why sometimes pricing gets illogical when the prospect of high growth is involved.

The more consistent the earnings and margins, the higher the multiple. Acquirers and investors flinch at uncertainty. If a company gets 20% gross margins every year for 5 years, people will pay more than if it got 10%, 30%, 20%, 15% and 25% margins over the same period, even though the average is still 20%; higher risk.

The more reliable the revenue source, the higher the multiple. Utilities have a highly reliable revenue source and their multiples reflect that. People need water, heat, and light every day and are willing to pay. At the other end of the spectrum, a commercial contractor that only does new construction will have a low multiple, maybe less than the typical range. The company is always out trying to find new business and the new business depends upon the economy,local governments, competition and so on. It is much higher risk.

The more bidders, the higher the multiple. It is often true that when you have more than 1 bidder you can push the price higher. That is greed.

To get a better idea on the multiple for your business, speaking with an advisor, appraiser, or consultant may be worth considering. While the market will set the multiple on your business, an experienced advisor may be able to provide guidance as to where the market will be.

Even if you are not selling today, it is always a good idea to understand the factors that drive the value of your company and look for ways to increase your value.

Author: Charles Lehnbeuter

©2019 Neubaden Group, LLC

#charleslehnbeuter

#neubadengroup

#whatismybusinessworth

#businessvaluation