Buying a business may be easier and safer than starting from scratch. Valuing a business is difficult. Emotionally-driven sellers may overvalue their businesses. Buyers must consider profit when setting price.
When getting a thorough, unbiased estimate of a company’s value from an impartial third party, it is important to consider the type and size of the business you want to buy will determine scope and cost. Experts use various methods to determine a business’s fair market value.
At Credo, our due diligence report includes an in-depth company analysis based on our experience in value creation and business valuation. We estimate the company’s intrinsic value and suggest ways to improve it.
Here’s how we do business brokerage.
Valuation is Key
Acquisitions hinge on valuation, and the same goes when selling an entity. When identifying the value of a company, you have to know the cash flow’s present value net of taxes and an annuity allows that and you can do that with any asset that generates income then discount that to the present value.
Justification of the Asking Price
With that premise, the typical arrangement when you have an acquirer is to look at another entity called the target. And we typically use that in a small business: the buyer looking at the target, at the acquirer – all these are very synonymous. But as we look at the target, let’s say the target’s worth is $10 million. As you piece them all together, the seller (or the target) might say, “Hey, I’m worth $10 million”. But the buyer would say, “You’re worth $8 million”. So there would always be disagreements on this. But let’s assume today that both parties agree that we’re worth $10 million.
And the target says, “If you offer me $10 million, I’m going to yield $10 million but just through my normal operations. So either I’m going to either hold out for a better offer maybe from a third party or another third party.” You can negotiate and tell them that there’s nothing material that’s going to make you sell your business in this moment because it’s not sweetheart of a deal. On the other side of the equation is you never know what’s going through the mindset of a seller. They might say “I’m worth $10 million but I’m miserable and I need to get out. I’m tired or running this business. It’s killing me.” You can always come up with a hundred different things because business is not easy. But let’s assume that is not the case. The compelling fact set for and salary is to get a premium – a premium on top of what the value is. And from the buyer side is we have to believe that the premium is justified. Not because we feel good in offering a premium relative to the fair value of these assets.
The premium is always above fair value in competitive industries and economic cycles. So the $10 million is typically 30%. You want to start on this now because you’re not in a white hot space and you should charge a 50% premium.
With that 30%, we can justify revenue or cost synergies. If you’re acquiring a small business, we likely have salespeople in different geographies, verticals, partners, channels, and marketing programs. You can add a bolt-on product suddenly and your reach can grow without additional sales and marketing. You may also be able to touch markets or you can add that product or service into your own offering, boosting its value.
You can grow the company’s revenue and profit at a faster rate (or a better rate if we’re being technical). And that’s premium-justifiable revenue synergy.
Minding the Gap
The other way is to mind the gap. Cost and expense must justify any premium. Costs must be specified and rates must be negotiated to improve gross margins.
However, the typical synergies that we see on expenses are on the SG&A side like sales and general admin. And that’s a pretty big pool of expenses. Check the headcount and know which roles are redundant. There would always be a subset of the leadership team. Maybe you need to have different capacities. You need to have a variable campaign that is related to the type of expense. It all comes down to identifying the things that are redundant.
Assess the Infrastructure and Facilities Costs
When it comes to infrastructure and facilities costs, you have to evaluate if there are pretty significant expenses such as redundant third party vendors, unnecessary facilities, or licenses and software costs that you can get rid of.
Consider a Combined Entity Perspective
Ask how you can grow revenue using the acquirer’s knowledge and product marketing expertise. Ask how you can shed some of that expense so the combined entity pro forma yields better results and not just valuation nuance.
We should look at what it would look like if you combine the two entities. Check if you’re better on a combined basis (accretive) or worse if not combined (dilutive). Showing a positive ROI rather than the present value of the cash flow is the punch line for valuation.
But the synergies don’t happen overnight…
Here’s the final wrinkle. It takes time to schedule and integrate them. You must understand how projected synergies manifest because the time value of money may be further and further out if you have poor performance, execution, and management. If your entire present net value is based on this assumption, you barely have positive north of zero, justifying the 30% premium. If these projects are delayed six, 12, 18, or years, future cash flow becomes riskier. Your cash flow should be able to suggest if you are doing the right acquisition.
Why You Need a Credo Valuation Expert
Valuing a business for sale involves many factors and methods. A company’s brand and reputation may also contribute to its value. Balance sheet values are a good starting point, but deeper analysis is needed.
That’s why you need the business valuation expertise of Credo CFOs & CPAs. We have vast experience in valuing, modeling, and analyzing business interests and their underlying assets, including in the context of M&A, strategy, restructurings, and tax financial reporting compliance. Our valuation services help you make decisions with confidence, improve your results, and help you get ahead of key issues.
Read here to know more about our business valuation services.
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