Internet Radio- 21st Century Entrepreneur | “Build Your Legacy Through Your Business” | Aired Friday, September 11, 2015 at 12 NOON
This Friday September 11 we will be airing another episode of “21st Century Entrepreneur” which is an Internet radio program aimed towards educating business owners and their advisors on how to make their businesses more successful and profitable. It is a show hosted by JC Maldonado who is the CEO of BizGro Partners and Joan Pelzer, the founder of Joan Pelzer Media. This week we will be interviewing Joan. She will be live in Houston Texas at the Legacy Live Conference. For more info go to www.legacylive.com. The conference aim is to help entrepreneurs build a business that makes a difference and has sustainable enterprise value. We will be interviewing the coordinators of the event and further explore what it takes to build a business with true marketplace value.
Further, we have had some interesting shows of late which have featured interviews with successful entrepreneurs. To hear recorded versions of these shows, click on 21st Century Entrepreneur Archives. Feel free to touch base with us if you have any questions at firstname.lastname@example.org.
Finally, below is a blog discussing the true components of Business Enterprise Value which is a theme tied into today’s show.
What Is My Company Worth in Today’s Market?
Business valuation is one of the most misunderstood sciences in the world of business. The science of determining enterprise value for a privately held business is often complicated by business valuation analysts, accountants, and investment bankers alike, as well as convoluted by the business owner’s bias view of his/her own business’s worth. Finally, the manner in which public companies are valuated brings bewilderment to owners and advisors alike who have lost touch with the reality of how the privately held enterprise is valuated. In this article, we are going to give you a 2 prong formula for determining your Business’s Enterprise Value which can be used as a tool of awareness for structuring relationships with partners, banks, vendors, customers, and potential 3rd party buyers.
Knowledge of Your Company’s Enterprise Value is Important
The cliché “a business is worth whatever a buyer pays for it” does not inform us of anything with regard to a Business’s Enterprise Value. This adage is useless in the real estate business as well. If you were to sell your home, you would consult with a realtor or an appraiser to get a sense of what your house would sell for in any given market before you decide to sell your property. This analysis can help a home owner decide whether it is worth pursuing a sale. Anyone can get a dream price and hit the lottery, but a property owner will not know whether he hit the lottery, unless he knows what the probable value of his asset consists of. These rules apply to a sale of a business as well. Anyone could come out of the woodworks and give you a great deal, but knowledge of your business’s conventional enterprise value is critical to any deal you make.
Determining a Company’s Enterprise Value
It is hard to consider a new paradigm for determining business enterprise value, without considering how a typical acquirer purchases a business. Typically, a buyer of a company will buy a business based on its earnings which is simply the amount of salary and net operating profit an owner derives from the business. This earnings number will usually determine the price of a business because generally a privately held business will trade for a multiple of these Earnings. Hence if a business is producing $300k, that business may sell for 2X Earnings which would result in a selling price of $600K. A higher Earnings producing business, one that produces $750k, may sell for a multiple of 3, leading us to a price of $2.15MM. Finally, a business producing over $1MM in Earnings may trade for 4X earnings which would result in a selling price of $4MM. As a general rule, the higher the Earnings a business produces, the larger multiple of earnings it would yield because the business can afford to be sold at a higher price and still cover a certain amount of debt service and produce a certain return on capital. Of course the business’s stability, comparable sales in its industry, and standing will also play a role in the determination of price.
In addition to price, the terms in which a buyer will make deal will come into play in the negotiations. Typically, a buyer will not pay a seller all the money upfront out of fear that the seller will not cooperate with the buyer post-closing for the purposes of transferring control of the business into the buyer’s hands. Hence as an incentive to do the right thing buyers will often require a seller to finance part of the transaction and receive part of the price overtime with interest as if the seller was a bank; this is known as seller financing. In other instances, the buyer may want to make part of the purchase price contingent on the future performance of the business; in the Investment Banking world this is known as an Earn Out. The business’s risks associated with transferring over the income potential making of the business normally dictates how much terms the seller has to extend to a buyer to make a deal. These transfer risks are known as Goodwill Transferability risks and is what has most impact on a deal. Examples of Goodwill Transferability risks are customer concentration (one or two customers making up more than 20% of the business), product concentration (most of the sales constituting the sale of one or two products), supplier concentration (one supplier supplying most of the business’s goods), salesperson’s concentration (one salesperson bringing in most of the revenue), declining sales, declining industry, and lack of management infrastructure which keeps the owner(s) tied into the business. Goodwill Transferability will typically determine how much money upfront a seller will receive in a deal.
Earnings + Goodwill Transferability = Business Enterprise Value
Hence, after considering how real world buyers determine Enterprise Value, you can conclude that Earnings will determine the Price and Goodwill Transferability (the likelihood the Business’s Earnings will be transferred to a 3rd party buyer) will dictate the terms of any given business sale transaction. This formula coupled with the industry and the business’s standing will determine Business Enterprise Value.
What about the value of my name, my equipment, my intellectual property?
So you may ask what about the value of my name, equipment, inventory, or intellectual property? All of these items are assets and may have independent value if it was sold apart from the business. However, oftentimes these assets do not have a lot of independent value from the business, although it may be possible to retain value from these assets separately. Nevertheless, these assets are perceived to have value within the context of the business and the business’s value will always be determined by the income it generates. As a rule of thumb, if the business is not generating income, these assets have very little value.
Buyer will not pay for potential
Another question is what about the potential my business has? Isn’t that valuable? The answer to that question is potential unrealized will not result in Enterprise Value, unless you have developed a business that has unique strategic value to its purchaser and that buyer cannot find such value elsewhere. With that said, buyers will oftentimes decide to acquire a business because of the improvements that can be made after the sale. However, this element only influences the decision to purchase, but will not necessarily influence the price and terms that are negotiated.