Properly valuing a privately held company or family business is a sophisticated, nuanced, subjective science that requires significant knowledge, experience, and skill. On the first tier of the computation, it is an investment calculation requiring recasting of financials and conversion of a risk assessment into a multiple. On the second tier, it is similar to valuing art or speculative investments such as sports memorabilia. Who would have thought a pristine stored Wayne Gretzky trading card bought in 1979 could be worth almost $4 million today (https://www.sports-king.com/wayne-gretzky-rookie-card-4111/). Layer on this the fact “past performance is not indicative of future results” under successor executive management (https://ibainc.com/blog/gregory-kovsky/the-one-company-asset-that-cannot-be-sold-in-a-ma-transaction-ownership-executive-ability/) and the difficulty in valuing a business comes into focus. A common solution to being overwhelmed by the prospect of having to take a position on the value of a business in the mergers & acquisitions industry is to not price the business and take it to market in an auction format. After all isn’t the classic definition of a “fair deal” what a willing buyer & seller agree to in a good faith negotiation. But does that strategy benefit the seller or buyer? As a thirty-two-year professional selling privately held companies and family businesses and the President & CEO of the largest & oldest business brokerage firm in the Pacific Northwest, I believe the auction methodology benefits two parties, but not the seller. I believe the strategy benefits the buyer because they get to take the first position in justification of the value and as a result put the seller and their broker on defense at the outset. Second, I believe the strategy benefits a less experienced, knowledgeable business broker because they are not forced to justify a value that was arbitrarily set, have the difficult conversation with their client about the true market value of their business before going to market, and/or have the potential to get paid despite delivering less than a premium market value for their client.
I believe a comparison to the valuation of residential real estate provides an excellent analogy for the components necessary to properly value a privately held company or family business.
The valuation of real estate starts with an assessment of the land. Raw land with access to road and utility infrastructure has greater value than land where these components will need to be provided. Real estate in areas adjacent to water or with views will exceed the value of ones without those attributes. All other things being equal, a larger lot size will be more valuable than a smaller one.
The land equivalent in business valuation is the historical financials of a company. A company with numerous years of strong financial performance commonly has a greater value than one with only a few in the same industry. A business with financials that can be scrutinized in detail by a buyer, their CPA/CFO, bank, and/or investors will be worth more than a similar one that deviates significantly from GAAP principles. A company with wide customer distribution will deliver a higher price in the marketplace than one with significant customer concentration in a few. All other things being equal, a company with more revenue and higher EBITDA will sell for more than one with less.
The second value building component for a residential home is the square footage and quality of the construction. A one room cabin without utilities or road access on a view lot will have less value than a 4000 square foot house on the same lot with paved entrance access. A recent kitchen remodel (https://www.thisoldhouse.com/home-finances/renovations-that-give-you-a-return-on-your-investment) will enhance a home value above what would be received for a kitchen that is twenty years old in design, materials, and appliances.
The comparable valuation component in a business sale is the furniture, fixtures, equipment, and vehicles of a business. Assessments of their age, capacity, and quality will influence business value. Well maintained, current vintage equipment has a higher value than dated tangible assets approaching the need for replacement. A business with the ability to produce more revenue and enhance its staff at its present location is worth more than one that will need to move to grow.
The third value enhancing component for residential real estate relates to what is in proximity to the property. Homes in districts with quality schools sell for more than ones in lower performing academic areas. Houses on golf courses or in historic neighborhoods sell for more than ones adjacent to major arterials, highways, or airports. Homes within walking distance to amenities such as restaurants, music venues, libraries, and parks frequently have higher values than ones further removed from those areas.
Similar to the importance in valuation to what is in the neighborhood surrounding a home for a business are the industry and geographic area where the company is based. This valuation component requires local and industry specific knowledge to assess intelligently. A business broker who has successfully completed transactions in a specific industry knows the level of market demand that exists in the sector and the buyer perspectives that result in premium prices at time of sale. Most people are familiar with Bass Pro Shops (https://www.basspro.com/). Bass Pro Shops have not been historically successful in the Pacific Northwest. Why? The reason is Washington & Oregon have unique fisheries (Salmon, Steelhead, Dungeness Crab, etc.) not found in other parts of the United States, so their national knowledge & experience is largely not beneficial related to purchasing products and providing professional guidance. IBA sold Fisherman’s Marine & Outdoor (https://fishermans-marine.com/), a multiple location retail chain. Fisherman’s Marine & Outdoor knew how to advise anglers how to successfully bait their hooks for success in the Pacific Ocean, Columbia River, and Willamette River. If you want to achieve the best possible market value for a business, an entrepreneur should engage a business broker who knows how to bait a proper hook and where the fish are biting in your specific industry.
It is common knowledge that homes located in different municipalities have different values. On the Oregon Coast, a home in Cannon Beach will sell for a premium value versus one in Astoria. The same is true for businesses. Influences like local tax rates, road infrastructure, demographics, labor availability, and occupancy costs all can have a positive or negative impact on business value. The value propositions for engaging a locally based business broker are numerous including knowledge of market dynamics, databases of buyers, relationships with attorneys, accountants, bankers, & insurance brokers, and availability of confidential, out of the public eye conference rooms for meetings.
Fortunes have been made in real estate by correctly predicting urban growth and future desirability of property locations. Premium market prices paid at the time are seen as prudent business decisions in hindsight. In a completed acquisition of a company, a buyer is never concerned with what the business did in the past. The focus is on what it will do under their ownership. Pricing a business to incorporate future appreciation opportunity requires a mergers and acquisition intermediary with the ability to articulate intelligently a future value proposition. What is the value of a business generating $3 million in EBITDA that will grow to $4 million dollars in EBITDA in three years based on market demand for its products and/or services. How much of the growth is attributable to new ownership versus the positive momentum and staff put in place by a retiring owner? Is the value stronger if the growth is secured with multiple-year contracts or anticipated based on open purchase orders and bids made to loyal customers? Is the company more valuable if it holds patents and trademarks? Factors of this nature should be incorporated into all thoughtful business valuation models.
All business sales or acquisitions start with a position on business value. No transaction can take place unless parties agree to a price. Controlling the narrative related to valuation is in the best interest of a selling business owner. IBA offers complimentary professional opinions of the market value of businesses in Washington & Oregon to potential clients as a method of demonstrating our knowledge, customer service, and determining if we are a fit for professional representation with our 100% paid on performance business model for the project. If you are interested in having a business brokerage firm with over 4400 successfully completed transactions on its resume over the last 51 years value your company, please contact us. The businesses we sell traditionally have completed transactions within 10% of our initial valuation. All conversations with IBA are held in strict confidence.
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family businesses. IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.