Preparing a Company for Sale Key Takeaways
Reasons for Transactions
There are a variety of reasons a business owner wants or needs to sell a company. Some of these reasons might include: retirement, another opportunity arising, declining business, booming business, an outstanding offer, a changing economic landscape, and even personal reasons such as an owner’s declining health, family issues or boredom.
Defining the Sales Scope
Regardless of when an owner decides to sell, the ideation process begins with defining the sales scope and determining the ultimate objectives of the exit. Goal examples are: Transferring 100% interest to a third party, selling ownership to an employee, transferring ownership to a family member through a sale or gift, or creating an Employee Stock Ownership Plan for employee ownership.
After deciding when to sell, it’ll be imperative to know what the goal of sale is so that you can move forward with how to value the company.
Aspects of Selling a Company
The value of a company largely depends on the buyer. Is the buyer an independent third party? Is the buyer already a player in the industry? Understanding the buyer pool and the motivation behind the purchase can prove to be valuable to the seller.
Other key factors that play a role in value include the valuation date, the purpose, the level of value, and the standard of value.
Standards of Value
When beginning the valuation process, it is important to determine the standard of value to be used. Some standards of value include:
Fair Market Value is the value that ownership changes hands on a specific date and does not take into consideration a specific buyer or seller. It’s largely based on if there were a hypothetical buyer and seller, with very generic terms where both parties are aware of relevant facts, with no obligation to each other.
Fair Value determines the prices that will be used for transferring a liability between buyer and seller at a measured date. Fair value is used for shareholder disputes/oppression cases, shareholder buy/sell agreements that deal with internal transfers, or in more rare cases, business value in marital dissolutions.
Investment Value is based on specific requirements of a particular investor. This usually has differences in estimates for the business’ future earning power, in perception of the degree of risk and required rate of return as well as the differences in financing costs and tax status. This value also takes synergies into account with other operations the investor owns or controls.
Intrinsic Value should be based on an analysis of all fundamental factors inherent to the business or investment. It does not consider extreme aspects of market conditions or behavior. It’s the value that an investor takes into consideration based on available facts to be the “true” value that becomes market value when other investors reach the same conclusion.
Another Important Factor to valuing a company is valuation date. It provides a cutoff point for analysis and allows for comparison to other investments. It states what is known or knowable up to that date in the valuation report. Things that are also important to a valuation are: purpose of valuation, level of analysis, level of reporting, ownership interest.
Basics of a Valuation
The value of any business is based upon the present value of future cash flows, discounted at a rate of return that reflects the risk inherent in achieving those cash flow. In some instances, the future might look similar to the past, and historic cash flows are utilized to predict future operations. In other cases, future operations look vastly different than the past, which requires the business owner to forecast future operations. In either event, calculating the value of the business can be narrowed down to a couple main aspects.
- Cash Flow/Earnings– A valuation will consider historic as well as future operations in determining the level of cash flow available to the owners.
- Rate of Return– The rate of return is based upon the various unique attributes of the subject company. In essence, investors are considering the rate of return they can receive by purchasing the subject company compared to the rate of return they can receive from an alternative investment with the same level of risk. What sets a company apart from other similar investments usually boils down to company specific risk factors.
Planning Your Exit Begins Today
The need for planning an exit begins much sooner than you might think. By consulting with an exit planning team, the business owner can identify strategic areas where adjustments can be made to both their financial statements and the risk level of their operations. When adjusted properly, reported cash flow can be increased and risk reduced, thereby resulting in a much higher value for the company.
We look forward to assisting you with helping you prepare and work through your exit plan. For questions, reach out to Matt Stelzman.
