If you own a successful private business, you may want at some point to cash out and sell part or all of it to a buyer, but don’t want to go public. Instead, you seek out a deep-pocketed potential buyer, such as a competitor, a pension manager, or a hedge fund. To assign a value to the sale, you have to set a price based on sales and/or assets. We’ll look at both.
Annual sales are a common indicator of value and are often used in conjunction with service-oriented companies with few assets, low fixed costs, and little retained earnings. Each industry has an associated multiplier, which is then adjusted for the specific company. For example, an insurance brokerage may start with a multiplier of 2.5 times annual sales, but adjust it upwards if it is a strong performer. A related measure is based on cash flow (sales less expenses) rather than just sales. One technique is to calculate the net present value of future cash flows, based on a discount rate equal to the firms cost of capital or to current interest rates.
Suppose your company doesn’t have major cash flows or profits, but does own a number of assets? Then you will probably use these assets as the basis of your evaluation. Tangible asset value sets the floor on company price. Some intangibles may add value, such goodwill, contracts, and trademarks. Often, an appraiser is brought in to evaluate the company’s assets and arrive at a fair price.
Frequently, the cash flow projections have to be recast to account for whatever the owner removes from the firm upon exit. Owners typically charge a lot of personal expenses to the business – c’mon, admit it! This tactic lowers taxes, but also lowers profits. A new buyer recasts the financials to account for all the money the owner will no longer be charging to the company. This will raise the sale price. Conversely, selling owners need to fess up to lingering inefficiencies in the business, which tend to lower the sale price. To recast properly, include the following steps:
- Replace the exiting owner salary and bonuses with those of the new owner.
- Deduct all non-direct owner expenses, such as auto leases, profit sharing, and other perks.
- Adjust for leaseback arrangements for real estate, automobiles, etc.
- Deduct staffing that can be cut, because it will be.
- Remove extraordinary items, which by definition are not likely to repeat.
After you cash out, plan the vacation of a lifetime and enjoy yourself – you’ve earned it!