So What is a Sales Multiple Valuation?

A valuation multiple is an expression of the market value of a company when related to a particular value.  You can have valuation multiples based on certain assets, cash flow, reported earnings or other selected reported or calculated numbers.

For privately held businesses, often the multiple used in business sales transactions is a multiple of AEBITDA.  AEBITDA is Adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization.  This number is a good estimate of the actual cash flow that the buyer would expect to receive after purchasing a specific company.

There are many other methods to calculate the value of a business, including Discounted Cash Flow, but this blog post focuses on AEBITDA.

Often small businesses focus on paying the least amount of income taxes, so their published financial results may understate the cash flow that is being generated by the company.  Lower financial results can be generated by excessive write-offs of normally capitalized items, payment of executive high salaries, high amounts of payment into retirement accounts, and expensing personal expenses of the company owners.

An educated and experienced buyer often understands this and allows for adjustments to the actual numbers published by the company’s accountant.  Also if the company owners are not going to stay on with the company, then their total compensation is added back to the company’s estimated cash flow and the expected compensation that would be paid to someone brought in to run the company would be deducted from the estimated cash flow.

These adjustments are typically discussed and negotiated during the process leading to a sales transaction.

Once this AEBITDA is calculated, then a multiple is used to calculate the value of a business.  For example a company generating $4 million of AEBITDA in an industry where multiples average 4 times AEBITDA, would sell for around $16 million dollars.

There are many factors that influence what this multiple would be in each given business sales transaction.  To learn more about increasing the value of a business click this link.

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Don’t Be Afraid to Say No

Value Enhancement Idea # 18:

Often, as business owners, we are almost paranoid about losing customers – any customer at all.  But some companies would be better off if they did lose one or more customers.

Most companies have them – “The Hated Customer” that demands too much, pays too little in terms of price, pay their bills late, and demeans your employees at every possible opportunity.    They sap your energy, that up too much time worrying about and create a company environment that is not healthy.

And the amazing thing is that after a company makes the decision to fire and/or stand up to these customer bullies, most often we feel much better.  The decision to get rid of a particular customer or to say no to them can’t be made lightly or quickly.

But at the point in time that the customer is sapping the energy of your company, diverting the company from doing what it does best, or negatively impacting the finances of your company, then don’t be afraid to say no.

And if doing so allows your company to focus on what it does best and to build a better and stronger company, then this value enhancement idea is for you.


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The Exit Planning Process

Many different companies have described how they approach exit planning for the business owner.  The challenge is that for each business owner the process is likely to be unique.  Some business owners are focusing on selling their business.  Others are worried more about having their children and/or key employee take over the business.

But no matter the key planning objective many of the elements remain the same.

exit planning process

In every well constructed exit plan there likely exit the following key elements:

  1.  An evaluation of the value of the business
  2.  An assessment of the personal, financial and business goals for the owner
  3.  Personal financial planning
  4.  Improving the top and bottom line of the business
  5.  Reducing risks that exist in the business in order to increase the value of the business and improve its viability
  6.  Considering exit and transition options
  7.  Clarifying the goals of the owner
  8.  Choosing whether to stay in the business or to sell
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Will the 2012 Unified Tax Credit Be Continued?

The tax law signed by President Obama in December 2010 will expire on December 31, 2012. The top 2012 Unified Tax Credit, also referred to as the Unified Tax Exemption, until then will be $5.12 million per person.  Also included in this law was a reduction of the top estate tax rate to 35%.

The Unified Tax Credit combines an estate, gift and GST (Generation Skipping Tax) taxes into one exemption.  This feature continues, but not the maximum tax credit, nor the more favorable tax rate. There are other provisions that are set to expire.  One provision is the portability of any unused portion of the exemption to the surviving spouse.

There are two actions one should take regarding this likely change to Unified Tax Credit and with the unknowns of what will happen to the Unified Tax Credit:

  1. Consider taking advantage of the $5.2 million Unified Tax Credit and transfer gifts in 2012.
  2. Carefully review your estate planning if you have used formula based allocations to beneficiaries. Unexpected results might occur in 2012 or in later years, based on changes in the Unified Tax Credit and the portability feature.  One example of this issue is that a surviving spouse might receive nothing at all and everything would remain in the trust.

Unless changed, the Unified Tax Credit will be reduced to $1 million and the top tax rate will revert to the previous 55 percent.

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Business Exit Planning

Business Exit PlanningBusiness exit planning is the process of considering the options that are available to an owner and creating a plan that best controls how and when the owner exits from the business.  There are several business exit planning options that may be appropriate for the owner to consider, but they typically fall into the following two categories:

  1. Transfer the ownership to family members or employees.
    In this case, a business transition plan should be created that clearly defines who will succeed in owning and managing the business, what timeline will be established for this transfer and what actions have to be planned and executed.  More about this approach to business exit planning is covered in separate posts entitled “Business Succession Planning Strategies” and “Business Succession Planning Checklist.”
  2. Sell the company to an outside 3rd party.
    Selling a private company to a 3rd party should typically involve independent experts in business brokerage and/or investment banking.  Be aware of taking an unsolicited offer from a third party without having created an auction type of environment in which multiple buyers are encouraged to compete to purchase your company. A business valuation on your company should be secured from a qualified business valuation expert.  Once you have determined the approximate value of your business, look for strategic buyers who would be willing to pay even more for your business.Also consider the many different ways in which a sale can be structured in the definitive agreement.  Some of these will get you all your cash up front.  Others approaches use defined payments over time or based on specific performance.  These add risk to your getting paid and potentially reduce the amount of cash that you will receive.

Consider the tax consequences of each of the above business exit planning options.
Different business exit planning approaches may have different tax consequences that will reduce your ultimate net sales proceeds.

Get help from outside professionals.
Business exit planning can be quite complex and will likely involve important accounting, tax, legal, business valuation, financial planning, and estate planning issues.  Get help from experts in these areas and from a qualified exit planning professional.  If the business exit planning strategy is to sell the business, get help from business brokers or exit planners in finding and negotiating with potential buyers.

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Business Succession Planning Checklist

Business Succession Planning ChecklistThere are several different types of business succession planning strategies. Even though there may be a different business succession planning checklist for each different strategy, the following is a list of planning checklist items that should be considered:

  1. Define the timeline for your business succession
    The sooner this can be identified, the better.  Often implementing business succession planning requires accomplishing tasks over an extended period of time. Time is required to position the new owner/manager with customers, suppliers and employees. Time is required to implement a business succession development plan as described later in this article.
  2. Define how ownership will be transferred
    This requires defining how stock will be transferred.  Will the new owner be family members other than spouse or children?  When will shares be transferred if the new owners are to be the spouse or children?  What if the transfer is to the management team through a leveraged management buyout?  What if the company is going to be sold through an Employee Stock Ownership Plan (ESOP)?
  3. Create a business succession development plan
    This is often a step that is overlooked in business succession planning checklists. Each owner has different skills, personalities, and unique talents.  Often current owners in a business have complementary, but different skills.  Second generation family members have considerably less experience in running a company than the current generation owner.  Regardless of who will succeed to run the business, there needs to be a well- constructed process to evaluate the strengths and weaknesses of the new owner or manager and to determine how their skills, personality and unique talents can be used to best manage the company.  If critical weaknesses are identified as part of this process, then an employee development plan needs to be developed to address the weaknesses.  Or alternatively, someone needs to be identified within the organization or hired that will provide complementary strengths in these areas.
  4. Have a business succession communications plan
    Regardless of how the company will be transferred, a business succession communications plan needs to be developed that clearly describes when each stakeholder in the company is informed.  This includes family members, employees, customers, alliance partners, and suppliers.  And for marketing reasons, the general public should be notified.  Competitors will take advantage of changes in ownership or management, so be clear in communicating how this change will be positive for the business.
  5. Develop a business succession planning checklist action plan
    Once you have decided how to transfer ownership/management of the business, create a detailed business succession planning checklist action plan with tasks, due dates, and assigned roles.  Often business succession planning involves many steps and occurs over several years, so creating a written plan, tracking results, and making changes to the plan on a regular basis is critical to staying on the planned timeline for business succession.  This business succession planning checklist action plan should include outside help from attorneys, accountants, insurance and exit planning professionals.
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Business Succession Planning Strategies

Business Succession Planning StrategiesThere are several different business succession planning strategies available to a business owner who is looking to transfer either ownership or management as part of their exit strategy.  These business succession planning strategies are typically alternatives to selling the business to a third party.  However these business succession planning strategies may be used a part of an exit strategy that transitions ownership or management prior to a third party sale.

Three of these business succession planning strategies are listed below:

1.  Family Business Succession Planning
The best approach will likely vary based on whether the transfer is to a spouse, sibling, children, or an extended family member. But the following issues will likely be common to any family business succession planning strategy:
a.  Has the family member been working in the business?
b.  What are the strengths and weaknesses of the new business owner/manager?  What should the company do to offset their weaknesses?
c.   What are the things that the new owner/manager is best at doing?
d.  Are there other family members that will be affected by the selection of another family member to run the company?

2.  Partner/Owner Succession Planning
Transferring ownership from one owner to another owner is often used for a retiring owner to leave their shares to another owner.  Many small companies have buy-sell insurance to enable this transfer, should one owner pass away. Or perhaps one owner doesn’t want to be involved any more in owning and running the company and just wants to get out as their exit strategy.

In these cases, the business succession planning strategies typically include a valuation of the business and a buyout of the departing owner.  This buyout exit strategy might be facilitated by a loan from a bank, be paid as a note over time, or paid outright by the remaining owner(s).

It is important that this business succession planning strategy be discussed early in the partner relationship, so that there are no surprises in the exit strategy process.  It is particularly important to have a written agreement on when and how any such transfer in ownership would be implemented.

3.  Employee Business Succession Planning
Many small business owners have been planning to leave the company either to family members or to their employees.  Transfer to employees is often limited by the ability of employees to have enough money to pay for the fair market value of the business.  With advanced planning, deferred compensation plans can build up values for the employees which can be surrendered for shares in the company.

For companies with 20 or more employees, the benefit of selling your company by setting up an Employee Stock Ownership Plan (ESOP) may outweigh the cost of setting one up. If this business succession planning strategy is potentially of interest, the business owner should consult with an ESOP specialist to determine if this approach is appropriate as the best possible exit strategy.


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Business Transition Plan

Business Transition PlanIncreasingly owners of business want to slowly transition from their business and not merely sell the company and walk away.  This change in behavior has been partially attributed to the attitudes of the baby boomers, who want to work later in life than previous generations.  This interest in having a business transition approach has been driven by recent economic considerations of the recent recession and the prospects of a slow growth economy for the immediate future.

But no matter what is motivating an owner to develop a business transition plan, having a written business transition plan is an important aspect of strategic planning for today’s small business owner.

There are several strategic approaches for today’s small business owner to generate cash from the business they have built, and be able to continue to work in their business:

  1. Build a strong management team that is able to take on more and more of the day to day activities that traditionally had been done by the small business owner.
    For many small business this may be the best answer.  This takes continued investment in growing your management team, but the stronger the team, the less that owner has to do to run the company.  In this way, the owner keeps the company and transitions to an advisory and oversight role.  If done properly, annual cash flow generated from the business can be added to the owner’s retirement assets.  And then eventually the company can still be sold.
  2. Sell the company to another company that values the ongoing contribution that the current owner can make to the new company.
    Many buyers in today’s market are asking the current owner to stay on for one or more years after the business transition.  In some cases they want to retain the current owner to run the business on an ongoing basis after the business transition plan has been implemented.
  3. Sell part of the company to a private equity firm.
    If the company has a good history of profitability and/or good reasons to project future profitability, they may be a candidate for what is usually referred to as a recapitalization.  In this process a private equity firm purchases part of the company, usually a controlling interest.  This generates immediate cash to the owner.  Typically the private equity firm keeps the owner to run the company for an extended period.  They usually only replace the owner if the company fails to continue to generate adequate profits for the investor.
  4. Slowly ramp down the revenues and expenses of the company over time.
    This is the option of last resort for a business transition plan, but many small businesses don’t generate enough cash to interest most buyers or they are professional services firms that are highly dependent upon the owner’s expertise.  If this is your choice make sure that this is planned for and that expenses are curtailed as revenues fall off.  Even a company with less and less expenses can be kept profitable during the transition period, if properly managed.


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Succession Planning for Small Business

Succession Planning for Small BusinessSuccession planning for small business can refer to two different circumstances:

  1. Planning for a Smooth Transition to New Owners Should Something Happen to the Current Owner.
    This type of succession planning for small business focuses on making sure that there is a written plan that clearly defines to whom the business will be sold and/or how the company will be managed if something happens to the current owner.  Often insurance plays a part to support a buy-sell agreement between partners or to fund the purchase of shares from a party who uses the insurance proceeds to purchase shares in the company.  Insurance can also play an important role should the owner become disabled and is not able to run the company.
  2. Succession Planning on How to Sell the Business to Internal Parties.
    Succession planning for small business is becoming more and more an important topic for consideration by small business owners.  More and more the children of small business owners are not interested in taking over the business, so succession planning for the small business owner becomes more complex. If they are not going to sell to their next generation so “To Whom Do They Sell”?  One approach is to sell to the current management team or to the employees through an Employee Stock Ownership Plan.  Both of these approaches are likely to need some financing from outside parties.

Some of the succession planning for small business steps are the same for both circumstances. It is important that the following actions are taken:

  1. Make sure that the sales price is based on a credible business valuation. This can be secured from a variety of sources, including accounting firms, business brokers, exit planning firms and certified business valuation specialists.
  2. Make sure that the change in ownership is clearly communicated to employees, customers, suppliers and any other stakeholders in the business.
  3. Get professional advice from insurance specialists, exit planners, and business transaction specialists on how the transfer can best be accomplished.
  4. Create a written plan that documents your plan.
  5. Review your plan with your accountant and estate planning advisors to fully understand how any such succession planing activity will impact your taxes and estate planning objectives.


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How Much Can I Sell My Business For?

How Much Can I Sell My Business ForHow much can I sell my business for?  That is dependent on several factors.  Each of these factors are described briefly below:

  1. What Kind of Business Is My Company In?
    Product companies often sell for higher multiples than service companies.  Companies with recurring revenue streams sell for more than companies without recurring revenue. Industries with higher growth potential will get a higher multiple than low growth industries. Although gathering data on privately held industries is more difficult to secure, there are publications that provide general guidelines as to what has been the range of multiples for comparable sales for a given industry in the past.
  2. How Much Profit Is My Business Currently Making?
    One of methods used to value a business is to multiply the historic adjusted earnings of a company times a multiple that is based on the buyer’s required rate of return and the company’s growth potential.  This method is appropriate when the company’s past performance is a good reflection of its long-term potential.
  3. How Much Profit My Business Can Make in The Future?
    If the future outlook is much better than in the past, then the best way to determine the company’s current value is to use a Discounted Cash Flow method of valuation.  This is based on forecasts of future performance.  But be aware that this method often comes with high discounts taken by the buyer because of future risks and unknowns.
  4. Is There a Strategic Reason for Someone Buying My Business?
    The highest price for which you can sell your business will likely come from a buyer that gains a strategic or financial advantage from buying your company beyond just the cash flow that it will generate from your current business.  A competitor may pay more for your company if this reduces competition in the industry.  You may have products or services that your buyer can sell in other channels or geographies.  You may have technology that can be used by the buyer.  These are just a few examples of strategic reasons for a buyer to purchase your company.
  5. How Much Risk Is There to the Buyer?
    Simple math.  The higher the risks in purchasing your company, the lower the multiple that will be paid.  Example of risks include the company being too dependent on the owner, having an unproven management team or products, or impending threats from a competitor.
  6. What is the Structure of the Sales Agreement?
    If the structure of the transaction is all cash, then a buyer will typically pay less for the business.  If they can stretch out the payments or they require an “earn-out” based on future success, then the sales price can be higher.
  7. How Much Time Do I Have to Sell?
    Generally speaking, the longer you can wait, the more likely you are to find a buyer who will pay more.
  8. What Are the General Economic Conditions that Impact the Sales Price?
    Interest rates, the availability of money from investors, and a variety of general economic conditions impact the multiple that people will pay.
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