Your company’s value may exceed expectations
Fair value for your exit strategy begins with objective analysis
By Alan Mischler, CEO, EndGame Success
Business owners at some point (or at several points over the lifetime of the firm) ask what the company is worth. Answering this question is highly problematic. When business owners have their end game in mind, high up in the tactics of any exit strategy will be a solid estimation of value. Often owners view of worth is overstated and there seem to be as many ways to calculate value as there are companies.
Perhaps this exaggerates the question, but you get the point. Let’s look at the financial world’s most objective method for valuation, commonly known by its acronym, EBITDA. EBITDA establishes net earnings (net income). And net earnings are a company’s profit after all expenses are paid, with interest, tax, depreciation and amortization added back. By looking at EBITDA over the past three years, you’ll understand (as will prospective buyers) the following:
- Revenue and expense patterns and trends that have had the biggest impact on value
- Product margins that generate the most and least revenue
- Where your company’s strengths and weaknesses deserve attention for increasing value
Earnings before Interest, Taxes, Depreciation and Amortization is the full name. It is the most commonly used measure of company financial worth and valuations are typically derived as a multiple of EBITDA. The multiple also takes into account your company’s marketplace, sales forecast, customer profile, competition, employees and management team.
The reason EBITDA is employed as a metric for financial performance is because it standardizes accounting differences between businesses that choose to handle those variable items differently.
Beware, however, not to confuse EBITDA with cash flow. There are ample examples where companies have positive EBITDA (or net income) but are in dire straits when it comes to cash.
Appraisers, investors and banks multiply the EBITDA figure with the industry standard factor to arrive at an approximate worth of the business.
For example, in 2013, the average multiplier for EBITDA within the Aerospace and Defense industry sector ranged between 8 and 10. So an aerospace business with an EBITDA of $5M was estimated to be worth approximately $40 – $50M, eight to10 times EBITDA.
An important factor for EBITDA is its time period, typically the prior 12 months. Among accountants and lawyers, this is also called the trailing period and is referred to by the acronyms TTM (trailing twelve months) and LTM (last 12 months). They mean the same thing.
Now, before you do the math, know this: many factors impact a company’s trailing period EBITDA. These factors include but are not limited to:
- The backlog or pipeline of customer business
- Track record with customers
- Marketplace traits
- Customer service reputation
- Management team issues
- Employee issues
This list can include other factors that may be unique to a business. For example,
- A trucking firm’s TTM might include weather conditions that impacted the ability to deliver (such as anticipation of El Nino conditions that might close roads)
- A factory meat supplier might have faced a shortage or glut of commodity pork, beef or chicken, impacting market prices
- Or a small manufacturing company might not have been able to acquire needed capital equipment for more competitive production due to a severe backlog. But the backlog has now eased.
At the end of the day, therefore, the EBITDA is just one data point used in determining the worth of a business.
Many professional business appraisers specialize in company valuation. Engaging a track-record and industry knowledgeable professional is a reasonable and wise step to take when considering an exit strategy. Like professionals everywhere, the best appraisers aren’t inexpensive. But you’ll acquire documentation of company value that will take virtually all factors and data points into consideration, producing fully-supported valuation for your company’s worth. This is one step of the process I call EndGame Success.
Another key point (and one relative to your management team) and a valuable exercise as you think through the process of selling your business, is to imagine yourself removed from the company’s operation. This means you’ll look at your business as if you aren’t there to run it. It’s not you who will be making all the important decisions after the sale.
Selling the company usually means that you will exit and that is the desire of most business owners. You will not be human capital included in the sale. A savvy buyer will question how well your company will run without you. If you don’t feel comfortable with the answer, you can take that as a firm indication of where you should start to create greater value for your business.
For further insight into the human capital problem involved with exit strategies, please see my article The Value of Human Capital [link]. Given insight and time, you’ll be positioned to increase company value through timely personnel decisions. And the increase may amount to a lot of money.
Keep in mind the age-old adage that the worth of anything is the price that a buyer is willing to pay and a seller is willing to accept.
As CEO of EndGame Success, I’m available for a no-cost consultation about valuation and your full exit strategy. And, I’m ready to answer questions and respond to comments about this and other articles. Click here to send an e-mail.
Contact me today to get started on your own exit strategy!