Using Price Multiples Can Cost you a Lot of Money

Written by Mark Richardson for the Business Transfer Advisor

Almost every business owner I meet who is considering selling their company asks me about using pricing multiples. Before I answer their question, I ask them to think about two very different manufacturing companies in the same industry. Each business has annual sales of $12,000,000 with a net income of $700,000.

Company A has been in existence for over 20 years. While gross margins are adequate, Company A prices each new manufacturing job on a bid-basis, and negotiated jobs are based on the owner's personal relationships with the customer. Product quality is good, but Company A's equipment is aging, and there is a significant amount of deferred maintenance. The firm is highly leveraged, and working capital constraints limit the amount of new work the company can take on. Sales have remained at the current levels for the last three years.

Company B develops and manufactures products, and sells them through diverse distribution channels. Customers contract for future delivery, and Company B uses a sophisticated inventory management program to plan production and control costs. Research and development programs have resulted in new products and top line revenue growth of 15% annually over the last three years. Company B's management team runs the daily affairs of the business, and the owner works on the company's future. The owner arranged an outside board of directors and advisors that hold regular meetings. The company's accounting firm prepares reviewed financial statements annually.

Which company is worth more?

Using a common industry multiple may result in overvaluing Company A and undervaluing Company B. Business valuation multiples simply represent a summary of trends based on a broad range of completed business sales. The multiples are industry specific, offer a wide range of estimated value, and do not consider the payment structure. As a result, multiples are generally used for smaller businesses.

As an alternative to using multiples, business owners should look at the company's value from three perspectives: economic, market and strategic.

The economic value of a company is what it is worth to the owner or, the monetary value required to replace the owner's current income stream and economic benefit.

Market value is what a new owner or investor is willing to pay for the company. Business owners should compare the company's market value to its economic value prior to going to market to determine:

• If a potential sale is viable
• If a sale will meet the owner's personal and financial objectives
• If an offer results, would it be something the owner would accept.

Strategic value is what a company could be worth. Businesses are purchased because buyers identify value drivers in the target company that can either improve or enhance the acquirer's existing business. Sellers who identify buyers' strategic objectives -- and position their companies to meet those needs -- negotiate better and receive higher sale prices.

Brokers, intermediaries and investment bankers may contribute information to transactional databases used to determine multiples, yet sellers should realize that specific deal values on private company sales are difficult to obtain and may be obscure. The real value in the transactional database research is that it identifies buyers -- which investors or companies are buying in the market today.

Finally, a comprehensive market evaluation is a valuable tool for business owners. During the evaluation process, the owner develops a deep understanding of the business itself, the client base, the assets, employees, industry focus, competitors, and intangible resources – from the viewpoint of a business marketer. Recasting the financial statements organizes the owner's current economic benefits. Most importantly, the evaluation identifies the high value drivers and low value diminishers, the most significant benefit of the analysis, because these factors help the business owner make the company more attractive to the market.

Sellers who reconcile the economic, market and strategic values of the business will gain a thorough understanding of the company and make better decisions than owners who rely on multiples and "rules of thumb."

Bidding at Auction? Here's 10 tips you need to know.

Auction Buyer Tip #1: Do not mistake auctions for retail sales. The two have very little in common. Auctions are different from retail because auctions are governed by federal laws, state laws, Uniform Commercial Codes and city ordinances. When you bid at an auction you actually enter a legal contract.

Auction Buyer Tip #2: You must have a bidder's card in order to buy at the auction. To obtain a bidder's card, you must put down a deposit for a bid card. This insures that you will pay for all your purchases that you bid on. Once you pay for your items or decide to leave the auction without purchasing any items, your deposit is immediately returned to you. If you do bid and win, your deposit is applied to the purchases.

Auction Buyer Tip #3: Be careful when you bid on lots. Know how much you are bidding and whether you are bidding against your spouse, parent, sibling or friend. Although you can retract a bid while the bidding is open, you cannot retract it once the auctioneer has said "sold". Auctioneers expect you to take full responsibility for your bids.

Auction Buyer Tip #4: The moment the auctioneer says "sold", the ownership of the item being auctioned has changed hands. This is the law. If your merchandise is later stolen you will still have to pay for it. It is no different than having your wallet or purse stolen while shopping at a store.

Auction Buyer Tip #5: Know what you are bidding on by closely inspecting each item before the auction. This is why an auction preview is offered. Use your own evaluation as your bidding guide, not the auctioneer's description or other bidders' comments. You are buying the merchandise "AS IS WHERE IS WITH NO IMPLIED WARRANTY" with no guarantees of any kind from the seller or auctioneer. The risk of the item not being what you wanted should be factored into your bidding amount.

Auction Buyer Tip #6: A fast-moving auction benefits both buyers and sellers. Auctioneers have the right to reject any bid amount that would slow the bidding. Auctioneers cannot wait for slow bidders, so know in advance what to buy and how much to spend. Your inability to keep up with the bidding pace is not the auctioneers' concern.

Auction Buyer Tip #7: Don't be shy about bidding loud and large. Raise your bid card in the air if you want an item and keep it up until you are done bidding. Make certain the auctioneer is aware you are bidding because the auctioneer may be taking bids from someone in front as well as online or behind you. Once the auctioneer says "sold," the item is gone even if you are willing to continue bidding. There are no do-overs in the auction business. Spotters or ring men are there to help the auctioneer spot bids and will signal your bid to the auctioneer.

Auction Buyer Tip #8: When the auction starts, you will hear a ring man call out a lot number and give a brief description of the item. The auctioneer will begin selling the item and will ask for you to bid. The auctioneer continues to go up in increments until the item has been sold. Once the bidding has closed, the auctioneer will say "sold" and state the winning bidder's number and the final price.

Auction Buyer Tip #9: During the auction, clerks record the description of your items and your buyer number as well as the amount you paid for the item.

Auction Buyer Tip #10: There are some terms that are used during an auction of which you need to be aware. These terms are "choice" and "all for one money." 

SBA Lending Report

SBA Weekly Lending Report - Statistics for Major Programs

http://www.sba.gov/about-sba/sba_newsroom/weekly_lending_report