Selling a Business: Know Where the Value Is
If you’re considering bringing a business to market – as a seller or as a business broker – do you know what you’re selling? Is the value of the business in the cash flow it generates or in its assets? You’ve got to know where the value is if you intend to realize the highest possible return for the sellers.
This question was posed recently when one of the readers of this journalistic tour de force asked about how best to proceed with a opportunity that came into his office.
At issue was a business that offered highly-specialized, high-end product to the relatively small group of high-income buyers in a major U. S. metropolitan area. The business did about $9 million in sales. The pre-recast net, as a percentage of sales, averaged about 15% over the previous five years.
Because the business’ product was very high-end – meaning very expensive with healthy margins – and its buyers were very high-income – meaning there were few buyers for the product – its very specialized inventory turned very slowly. But the inventory was not perishable nor was its demand determined by whatever the current fashion was. Therefore, unsold inventory rarely had to be discarded or even discounted – and could be sold years after it was ready.
Acrimony: The Reason for Selling
The owners of this business – a husband and wife – were getting a divorce and the business was the couple’s major asset. It needed to be monetized in some way and split between the two. The parties were, evidently, not playing well together. The attorneys involved thought that one option to monetize the business was to sell it.
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It turns out that the main product the business sells is both rare and highly-valued by the relatively small but well-heeled customer demographic that the business targets. As such, though the inventory moves slowly, when a sale is made, it’s often a whopper. So the inventory – its size, the rate it sells and the rate at which it increases – was going to be a key aspect of value.
And to complicate matters a bit further, the business manufactures its inventory; it does not buy it from a wholesaler. In this case, this meant that determining its cost of goods was going to be difficult. As a result, valuing the inventory becomes a challenge – mainly because as a general rule, when selling a business, inventory is valued at the wholesale level; its replacement cost.
I’ve written previously about how to handle inventory when selling a business. Business brokers are not appraisers of inventory no matter how common the product is. We don’t know what value 137 various models of BMWs would have when we sell an auto dealership. We don’t know what the inventory of a hardware store – all its nuts, bolts, screens, drill bits, plumbing supplies, 2X4s and roofing shingles, et cetera – is worth on any given day. We haven’t a clue as to the value a wholesale plant nursery’s plants, trees and mulch would have.
But the owners of all these businesses have a pretty good idea of what their inventory is worth. We ask them. Which is exactly what was done in this case
Do You Know Where the Value Is? Get Help!
The owners believed that the inventory has a value of at least $12 million – and possibly more – but that very few people would understand its value.
If “…very few people would understand its value”, this means that there are likely to be very few knowledgeable buyers and that expanding the buyer pool is going to require educating some unknowledgeable (not to say “ignorant”) buyers as to the value of the inventory and the only way to do that is to have the inventory appraised by a professional appraiser certified to appraise the specific product – of which there are, apparently, fewer than six in the entire country.
The Value of the Appraisal
Having such an appraisal will go a long way to help us determine the best way to realize the highest possible value for the client.
For example, a $9 million revenue business with a net that averages about 15% might have a value based on its earnings history and potential of something in the $3 million to $4 million neighborhood. But if the sellers are correct and business’ inventory is appraised at $12 million, it’s worth asking the question, “what are we really selling here?”
As you can imagine, there are several issues to consider.
- A business that is so specialized will likely have few buyers and finding those buyers will take some time.
- An inventory valued at roughly three to four times the value of the generated cash suggests that a liquidation of assets might be the best approach.
- What is the transaction number that the seller’s need to live the lifestyle they’re accustomed to post-closing?
- How badly does the couple want to be rid of each other? The answer to that question will go a long way to determining how to handle this deal.
Even if the inventory is appraised at $12 million, it is unlikely that a buyer will be found at the price. A buyer – and remember, there are unlikely to be many them – can be expected to try to negotiate a lower price. But even if it were to sell at a 50% discount, the sellers still will realize a significantly greater return than they would if they tied it to the business.
The Bottom Line
You need to know what you’re selling – and have a good sense of the value of the intrinsic parts of the business.
Next week I’ll describe what we recommended to the couple’s attorneys as the best way to realize the highest value of the business. It didn’t please everyone but nobody could argue that we were wrong. Divorces are rarely pleasant but when a business is involved, they can become distressingly disagreeable.
When a business is the major asset of a divorcing couple emotions often overrule logic. Owners are often so eager to be shed of their adversarial partner that they will often overlook the most financially beneficial exit – possibly because they did not have the right advisors.
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Our course, The Basic “How-To” of Becoming a Business Broker”, teaches how to become a professional business broker.
Become a Professional Business Broker…
If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a profitable week!
Joe
#business #businessacquisition #sellabusiness #becomeabusinessbroker #businessbrokering #businessvaluation #MergersandAcquisitionsThe author is the founder of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at jo*@Wo*******************.com