What's It Worth?
When Jim Hotze and Kent Watts decided to merge their businesses, they opted for a quick, relatively cheap "limited valuation" to determine the fair market value of each company.
Published February 1999
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Jim Hotze and Kent Watts decided to merge their companies, but first they had to figure out what each was worth
Jim Hotze and Kent Watts both owned successful companies that distributed business equipment, situated just blocks apart from each other in the Houston area. The two men even shared the same bank. But until their loan officers started talking about the two entrepreneurs--and the growth strategies each man had started to explore in response to rapidly changing conditions within their shared industry--the pair had never exchanged a word.
But as soon as his banker passed on the lead last spring, Watts made a cold call to Hotze and, hoping for some feedback and even contacts, broached the idea of selling his company, Wallace Business Technology Inc. As Hotze recalls it, he listened to Watts, rapidly calculated the possibilities, and then replied, "If I may be so bold, let's merge instead." Within minutes the men were meeting face-to-face over lunch. That was the first of a series of conversations in which they swapped their visions for future accelerated growth, their attitudes about family and business values, and, finally, their key financial numbers.
Two months later they were ready to consummate what looked to be a perfect union. Hooking up with Hotze's company, Patriot Group, which specialized in selling upper-end office printers to the region's largest corporations, offered Watts the chance to broaden the customer base of his business. In turn, his company, which sold a variety of business machines, serviced laser printers, and provided computer-network support, would provide Patriot with a servicing capability its customers and suppliers wanted. Hotze and Watts were convinced that together they could create a powerhouse that could ring up as much as $30 million in sales over the next few years.
One hurdle remained: figuring out how to structure the deal. Whose company was worth what? What Hotze and Watts wanted was a fair assessment of how much their respective companies were worth. Those valuations would allow them to weight their stock holdings in the new combined venture.
"We didn't want to argue or to turn this into a whole emotional thing," Hotze recalls. "What if Kent had said to me, 'My company is more valuable than yours because you need me,' and I had argued, 'My company is more valuable because it's bigger'? What we needed was a way to remove our egos from the process and just get a fair answer to the question." Sitting around his conference table just days before their merger finally closed, in mid-October, Watts agrees. "What we needed was a baseline," he says.
The way they got to square one was by hiring an independent appraiser to perform valuations on both companies. Those figures then provided the basis for the new company's equity structure. Neither man had ever paid for a valuation before. But despite the cost in money and in time, both owners are now hooked.
In many ways Hotze and Watts were stuck in the classic entrepreneurial bind. They knew they had successful companies and believed they could make them even better--but since the companies were private, neither knew how much the businesses were worth.
Was it revenues that mattered most? Since Hotze's company logged nearly $12 million in 1997 sales, compared with Watts's $1.6 million, was Patriot worth 7.5 times as much as Wallace Business Technology? (No.) How much did corporate history matter? After all, Wallace had been founded 51 years earlier by Watts's father-in-law. Did that make the company 2.7 times as valuable as Patriot, which was only 19 years old? (Hardly.) Then there were all those other ratios that might have held the answer. With 26 employees, Patriot logged about $461,500 in sales per staff member. With only 12 employees, Wallace had a sales-per-employee figure of $133,000. So could one assume that Patriot was nearly 3.5 times more valuable than Wallace? (No.) No wonder the would-be partners agreed to turn to an experienced outsider for guidance.
The pair began by consulting Watts's upscale, downtown law firm, which supplied them with a list of names, including a large local appraisal firm. "It was frustrating," Watts recalls. "Here it was, the end of March, and we really wanted to get someone here quickly so we could wrap everything up. But no one would return our phone calls--which we eventually learned was because the firm was so busy with valuations tied to taxes and the April 15 deadline. Finally, a guy came out and we tried to explain to him what we wanted."
Watts emphasizes: "We tried to explain to him what we needed. But he just told us it was going to cost us $8,000 apiece. And we told him, 'Wait! You don't understand. This valuation isn't for our bankers or the IRS. It's just for the two of us. All we want is a couple of numbers.'"
