What is My Business Worth? The Interview #separator

Nataliya Kalava, CVA, ABV, MAFF of American Valuations, interviewed Brian Stephens, MBA, CMAP, CVA, CBI, CEPA of Legacy Business Sales & Acquisitions about Valuation and answering business owners’ question of What is My Business Worth?

Summary: during our engagement conversation, we discussed market sentiment from the perspective of sellers and buyers. Brian shared insights about how sellers think about the value of their business. We also cover what risk factors and value drivers business brokers consider when working with buyers or sellers. As business valuation practitioners, it is imperative for us to be aware of the conversations and dynamics that take place in the market. It helps us to identify opportunities to bridge the gap between reality and expectations.

Nataliya: In your experience, what is the primary reason for the sale?

Brian: There are many reasons why a business owner may decide to sell their business. Some reasons may include selling a business for age-related and health-related reasons. An aging business owner may feel that they should retire or perhaps experience pressure from their spouse to start making exit plan(s). In other words, they feel like they’re “supposed to sell” the business, but in reality, they really don’t want to sell, but they feel like they have to do it. Another valid reason is simply the uncertainty of the future. When the times are good, and everything is going well, like in the 2015 and 2016 environment, during current economic conditions, a 70-year-old business owner who is running their business feels nervous about the economic factors, health/pandemic issues and does not know how potentially they would “dig out” of the adverse situation, if it takes place. All of these reasons are currently contributing to the motivation to sell.

Nearly 60% of the time, owners are retiring. Health, family issues and burn out each represent about 6% to 8% reasons owner sell. In 2022 we saw an uptick in owners responding to unsolicited offers and selling due to offers to buy them out even though they were not actually on the market. This may have been due to pent up demand on the acquisition side follow an ease in the covid concerns.

Nataliya: How do business brokers value a business?

Brian: Most brokers use market multiples to understand the value and to price the business. We look at previously sold companies using data from various databases, including PeerComps and DealStats. We also use data from the market transaction from our state database for business brokers. I typically use software or excel to calculate value. We interview the owner(s) and normalize their company’s financial statements. Another factor we consider during the valuation process is the company’s “bankability” factor. The Bankability test determines if you can borrow money and whether a business can be financed through an SBA loan. We also calculate to see if there are enough cash flows to support the loan. I use this data to show the seller if the price makes sense.

Nataliya: Which valuation methods are commonly used by business brokers?

Brian: Primarily, we use the market approach, supplemented by the bankability test. We use gross revenue numbers, subtract out expenses and incorporate adjustments or add-backs (total expenses + add-backs). Market approach (transaction method) + bank-ability test. We occasionally use an income or an asset approach. The market approach is often an easy way to help business owns and investors get an idea of business value. Of course, since every business is unique, we have to take great care in helping our clients appreciate the factors that there is more than just applying a mean or median multiple to their EBITDA or discretionary earnings.

Nataliya: Describe the difference between an asset sale and a stock purchase.

Brian: Generally, structuring a transaction as an asset sale is more common. In an asset sale, all tangible and intangible elements typically transfer to the new owner. In an asset sale, neither cash accounts receivables nor liabilities transfer. On the other hand, the stock sale, as the name implies, refers to the sale/purchase of a company in its entirety. With this type of transaction, you are concerned about potential liabilities and a lack of step-up basis in depreciation. There are options, however, such as 338-H10 election, which allows the buyer to structure a transaction as a stock sale and treat it as an asset purchase. The stock purchase might be necessary in certain circumstances, such as for medically related businesses because it would take a while to qualify for insurance (e.g., Medicare, Medicaid, and commercial plans).

Nataliya: As a follow-up question, what type of assets typically transfer in an asset sale?

Brian: In an asset sale, both intangible and tangible assets transfer. I should note that only those assets transfer that are necessary and pertinent to the operations of the subject business. That includes inventory and FF&E (furniture, fixtures, and equipment). The seller will also transfer social media accounts, website, customer lists, lease agreements, etc. Some assets are questionable and can complicate the process because they are part personal and part business. Try telling a business owner to go get a new laptop or cell phone number. Also, the use of cars (e.g., F-150 truck, the use of which is partially personal in nature) or rental property has to be considered and negotiated during the process. Business owners that understand the important of transferring their knowledge, systems, processes, relationship, culture, and brand value tend to be the most success. Whereas a tangible asset such as a company car can be done with a bill of sale and a trip to the DMV, the transfer of long stand customer relationships can sometimes take time. We are just closing on a wonderful legacy business where the owner will be on contract to help the business for a full year.

Nataliya: Do sellers typically invest in either business valuation, real estate, or fixed assets appraisal?

Brian: Occasionally, they would invest, but not nearly enough. If they did, they would have a more realistic understanding of the value of their business. The responsibility of the advisors is to help their clients understand why they should invest in getting an appraisal. The client will have a better understanding, and it can be used as an excellent tool for the buyer community to justify the price. Independent, objective, third-party business valuations are required as part of the SBA loan process. The lender would typically order a valuation. When I have the benefit of sitting with business owners years before they intend to sell, I encourage them to get business valuation that also gives them insight as to how they could increase value and the ability to sell. Since the earnings a business owner get for his or her business often plays a significant part of the business owner’s total wealth at retirement, it is critical to understand what they can expect when they sell. Additionally, business owners getting valuations years before selling can empower them to know what they can do to significantly impact their selling price later. If the business owners waits until they need or want to sell, she or he may miss out on an opportunity to extract their potential wealth and sometimes miss out on being able to sell their business at all.

Nataliya: What are some of the critical aspects you pay attention to when working with a client?

Brian: First of all, I seek to understand the seller’s motivation. Why do they want to sell? A seller motivated by hoping to get a great price just because the market seems promising has one set of priorities. A seller who has spent 25 years running a business and now wants to spend time travelling and seeing grandkids but is not under any time restrictions is entirely different. Occasionally business owners reach out to us due to serious health issues. While the seller looking to retire but has no time constraints may wish to price the business above the market average, the seller with serious health issues may elect to price the business low enough to expedite the sale. Understanding motivation is super critical. Second, I focus on potential employee-retention challenges. Thirds, what systems and processes the business has in place? Fourth, what is the potential growth in revenues? Does the company innovate? What is the state of the equipment? Finally, is there a “fun factor” (some businesses are more pleasant to operate)? It is also essential to look at the brand value of the business. From the financial perspective, I look at the rent expense and company margins compared to industry standards. I calculate the margins for the top 25% of the comps (sold businesses) and compare the subject company’s performance. It certainly helps to align expectations with sellers and buyers.

When I work with the buyers, we consider the borrower’s financial ability to purchase a business; i.e., Do they have the money? Can they qualify for an SBA or similar loan. Do they have the background and experience to run this type of business? What is their motivation? Who are all the decision makers? Are they really ready to leave the comforts of what they have been doing, and embrace the life of a business owner?

Nataliya: What is the seller’s understanding of the value of their business?

Brian: Sellers often think their business is worth more than it actually is. Most of the time, business owners are too innocent about the value of their business. They are unfamiliar about the methods used to value a business. In fact, they may confuse and use EBITDA multiple and apply it to gross revenue, for example (which, of course, is incorrect). Basically, they will find a combination that is most beneficial to them. Many times, business owners think it has to do only with the financial performance of their business. They forget and do not account for the fact that other aspects drive the value of their business. For example, a business owner who takes six weeks of vacation cannot necessarily expect their business to be worth the same as the business whose owner does not take any time off. Currently, with rising interest rates, most sellers are aware that the market is changing, but they really need to be educated about their business’s actual value and price. Furthermore, business owners may need help understanding that they will need to spend time and energy after the sale to transfer the systems, cultural identity, relations and other intangibles we discussed earlier.

Nataliya: How amicable or responsive are the sellers to adjusting their price based on valuation?

Brian: The answer partly depends on the individual’s personality and motivation. Another element is the person delivering or sharing the value and their ability to communicate effectively with the business owner to explain the drivers, inputs, and assumptions. If the appraiser speaks well, they can explain to the business owner how the value was derived so they can’t argue with what has been provided. Sometimes, accountants are too analytical and don’t explain well in relate-table terms. Motivation also impacts whether there is a situation where the seller must get out of the business and sell. I would say at least a fourth of the people would be willing to adjust. People-relationship skills are essential. This issue again supports the importance helping business get business valuations years before the hope or need to sell. Business owners know practically everything about their business. But most know nearly nothing about what the market will likely give them for their business. We professionals serving business owner and valuation specialists in particular should appreciate the ethical good that is provided when one helps a business owner understand value early on. It gives the owner the opportunity to improve if they so desire and can drastically impact the whole of the business owner’s lives. But business owners do not know what they do not know. Someone must help them understand.

Nataliya: What are some key aspects that buyers of the business focus on?

Brian: Cash flows, of course, are important. Most buyers a acquiring a business, as opposed to starting one up because they desire or need to make money right away. Smart buyers often look for businesses that they can grow. If the buyer envision ways to increase value, they will find that more attractive. The business has to be priced reasonably. Valuations help both sellers and buyers make wise business ownership transaction decisions. Business buyers often expect to leverage their investment, so financing is another key aspect. Some sellers will provide financing, but SBA financing often provides the strongest leverage. SBA financing also makes many buyers feel that bank financing is additional validation that the subject business is a viable investment. When a business has come to properly understand the value of his or her business, they can initiate a conversation with a bank on the likelihood of buyers getting a loan for their business. Many buyers will look for business that are SBA-likely. Smart buyers also seek to understand the culture of the business and assess whether it is a proper fit for them. Culture and people seldom change rapidly with flourishing success. Buyers prefer ease of transferring a business and need to see themselves running it. Also, the complexity of running operations and the lack of licensing requirements play into the decision.

Nataliya: In your opinion, what are the key value drivers for a business?

Brian: this is one of my favorite topics when talking to business owners who are preparing their business for sale or thinking about selling their business down the road. One can imagine two nearly identical businesses, in the same industry, having a price for the same Bruce revenues in that profit and yet being valued at entirely different prices. Occasionally I put on a business owner seminar to help people understand value drivers. I ask business owners to imagine a two businesses in the same industry, both having been in operation for 25 years, both grossing about $2 million and netting $350K in EBITDA. And then say, imagine one has an owner who takes six weeks of vacation every year and the other where the owner never taken a vacation except one year to deal with a heart attack. Or one where the sales have been growing for the last five years to get to the $2 million, whereas the other business making the same amount of money in the most recent year has been declining for the last five years. I review the company’s customer concentration, revenue growth, owner not being an “essential/key” part of the business, repeating business, supply chain restrictions, or dependence on key vendors and systems and processes in place. Other factors or drivers include the longevity of employees, other key employees, do employees have a reason to stick around, and if they are appropriately incentivized. Buyers it when companies have effective mission statements, solid core valuation and written systems and processes that the employees truly value.

Nataliya: How responsive or willing are the sellers to hire an outside consultant or advisor to help them improve the business?

Brian: It helps when the outside consultants take time to build trust and invest time to understand the seller’s pain point and goals. It is hard for business owner to invest money and time until trust is established. Most business owners already know they have room for improvement so they need to be convinced that if the invest the time and money, that their lives and business will get better. Some industries require specialists, not just general consultants. I have seen several clients that have taken their business to a whole new level and really thrive once they establish great systems and processes. I am working an amazing wedding business who has engaged business coaching and advisors over the last several years and has developed one of the most systemized, smooth-running, happy-to-work-at, customer-centric businesses I have seem.

Nataliya: Based on your experience and observations, what has been the impact of COVID-19 on different sectors?

Brian: People inter-facing businesses in the hospitality sector, restaurants, and retail stores saw significant challenges. Buyers were reluctant to buy these types of companies. On the other hand, sellers wanted to appraise their business based on prior (pre-COVID-19) financial performance.

I had some clients and businesses that did far better than average during covid. The sellers wanted to capitalize on that. For example, we worked with a fishing retail company. Anything outdoor/ activity-related showed strong performance and demand. However, to be fair, we have to account for a non-recurring spike in earnings. In my practice, I weigh the last four years and give the year 2020 a lower weight (e.g., 10%). Typically, I allocated more weight towards the most recent year. In 2022, things were leveling off. Therefore, we have been emphasizing the more recent company performance.

I still observe that there are a lot of people wanting and looking to buy restaurants. Healthcare is another hot industry, including dental practices. There has been strong demand for urgent care centers. During the pandemic, the healthcare sector, specifically companies out of New York or Chicago, were looking to penetrate the market in the Southeast and do more online medical care visits or telemedicine. This meant that the practice’s older (pre-COVID-19) financial performance and numbers did not reflect the trend. To some extent, COVID-19 prompted innovation in the medical field and impacted how we do business.

Nataliya: What has been the impact of inflation and rising interest rates on transactions?

Brian: In terms of inflation, of course, rising labor costs are hitting the companies’ bottom lines. Most buyers look at the most recent performance and see the impact on the margins. In terms of interest rates, there is no significant impact yet. It is definitely a concern to the buyer community. However, I haven’t seen anyone complain yet, but obviously, the borrowers take into consideration and think about their ability to pay the bank back

Nataliya: On average, how long does it take to sell a business?

Brian: On average, across the board, it is about nine months, based on data from the business brokers of Florida. Some businesses take almost two years to sell. Some may take just a few weeks, but it happens rarely. When sellers have a business priced right, having a bank that can finance the purchase helps the owners sell the business. However, between 70%-90% of businesses do not sell because of either unrealistic expectations, customer concentration, or other risk factors, or the owner is “too much” of a business (key person risk), cost structure, etc.

Nataliya: What could be done better by business brokers/ sellers/ buyers?

Brian: Education is the key. Also, communication with clients and integrity. It is important to talk about flaws early in the process and be prepared. Brokers need to really listen to understand their sellers and their buyers. And brokers need to lead the process and have the courage to speak the truth, even when it is uncomfortable. The seller will benefit from taking time understanding the process and have all documents that he or she may ever need in one file (being organized).

Nataliya: How does a business broker help buyers or sellers navigate the process?

Brian: Business brokers help sellers understand the value of their business. They help to protect the sellers from a confidentiality point of view and bridge the gap between the bank and the business during a pre-qualification process for a loan. Business brokers help to develop a marketing strategy for the business and sort through the potential buyers. They set up serious buyer-seller meetings and support negotiations.

What to know more? Check out these great resources for how to sell a business in florida and how to value a business too.

https://buybizusa.aflip.in/SellEbook.html

Also use these links through the article

Visit Legacy Venture Group: https//BuyBizUSA.com

Great Video:https://bit.ly/4i8HUbb

When should I exit my business? https://youtu.be/FmR-ldQ4Nn0

What every business owner should know. https://youtu.be/WWK34EO49xE

What is my business Worth: https://buybizusa.com/value-my-business/

Free Business Value estimate: https://buybizusa.com/business-valuation-estimate/then the money https://youtu.be/0-ymn3vL0SE

https://buybizusa.com/seller-registration/

LINKEDIN: linkedin.com/in/stephensbrian

Afterwards create a title 60 characters or less, then a Meta description that is up to 160 characters