Far and away the biggest question business owners have when they are considering a sale of their companies is, “what’s it worth?” Naturally, providing these potential sellers with an answer to that critical question is one of the first steps in the Sigma DealMap™ process. While there are business valuation techniques used for wealth planning purposes, tax compliance, litigation support, partnership disputes, etc., our focus is on providing the business owner with the company’s “fair market value.” In other words, an approximate price the business owner can expect interested buyers to offer for the company. This fair market value technique is what Sigma Mergers & Acquisitions utilizes for business owners seeking an exit strategy.
Sigma Mergers & Acquisitions follows a valuation method that not only makes sense to our clients, but also produces a high level of credibility and success with potential business buyers. While some of these processes are proprietary in nature we can disclose that we employ both a science and an art to business valuations. Our process focuses on a knowledge of the business, knowledge of the industry and an understanding all of the value drivers of the business, which can include:
Each of these value drivers are critical to the valuation process, but the importance of reliable financial information naturally cannot be overlooked and to many buyers is the most important value driver. While many business buyers focus, in our opinion, far to much on financial information, we emphasize that financial data alone does not create or produce the true value of the on going business. Don’t get us wrong, we indeed examine closely the financial data and perform modeling techniques on the financial information.
Different valuation methods view earnings differently but based on the size of the company the cash flow of a business can be characterized as SDE (seller’s discretionary earnings), or EBITDA (earnings before interest, taxes, depreciation and amortization).
During the financial analysis phase we review primarily the P&Ls, balance sheets and tax returns.
The objective is to:
Determine the amount of “discretionary expenses” that are not essential to the day-to-day activities of the business
Identify those expenses that are non-recurring or are unique “one-time” expenses
Verify that the expenses associated with the owner qualify as add-backs
Analysis of the balance sheet (although we understand that many of the businesses we review have incomplete or inaccurate balance sheet reports)
Once the review of the financial data is complete and we understand how much money the owner truly makes from the business, we can begin benchmarking the company. In this step we are looking for sales of comparable companies. We start with a narrow and focus – SDE, revenue, industry, geography, timing – looking for similar businesses, and then expand our search from there. Ultimately we are trying to determine what similar businesses have sold for recently.
Additionally, this benchmarking extends beyond comparable sales and into industry standards. Each business type has specific valuation parameters that can differ greatly. For example, landscaping contractors are traditionally valued using different multiples than software developers. So based on the company’s industry, we want to understand those standard metrics as one aspect of the business valuation.
No valuation would be complete without reviewing the “multiple” concept that is so widely employed by business buyers. Unfortunately, we find that many business brokers and prospective buyers alike often focus strictly on this concept as a sole means of determining value and do not consider the underlying factors of the valuation process. Too many variables, or value drivers, exist to just routinely apply a multiple to SDE or EBITDA in order to establish a value. This approach, as a singular solution, is a disservice to the client and one that fails to provide a professional level of representation. Sigma does not take these shortcuts. So while multiples are important to the business valuation, they shouldn’t stand alone – taking into account the value drivers shown above, as well as many others, is the only truly fair way to determine a company’s actual market value.
Even after all of this detailed analysis, one last step remains – making sure the numbers work. Specifically, based on likely financing sources and the size of the transaction, does the business generate enough free cash to accomplish two main factors. First, how long does it take the buyer to recoup his or her equity injection, and second, how much of the business free cash is servicing debt from that acquisition? These are key ratios that need to be analyzed to make sure the value placed on the business provides adequate returns in both of these instances. If thee ratios are out of line, then the valuation methodology needs to be revisited to see what caused this outcome.
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