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Valuations 2004: What's Your Company Worth Now?

How, and by whom, valuations are established.
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After a string of rough years and falling values for private companies, here's some good news: Now just might be the best time to sell a business that we've seen in quite some time.

Why? Jay C. Jester, marketing director of Audax Group, a Boston-based private equity and mezzanine firm, explains that many private equity companies and venture capital firms raised money for investment funds with capital-deployment time limits several years ago, and now the clock is ticking ever closer to midnight. "There's a ton of private equity with a fuse on it," Jester says. "You've got pent-up supply and pent-up demand coming together. There's activity in just about any sector you can think of." Of course, some sectors are hotter than others. Right now, telecommunications equipment and semiconductor companies are starting to fetch good prices again as those industries bounce back after having been down for years. For obvious reasons, companies involved with various aspects of security are hot -- home security systems, devices that control access to buildings, retinal identification. Many companies dominate various niches of the medical instrument sector, and as the population continues to age they'll command premium prices.

During the past several years, as the market stagnated, buyers eased their demands that acquisition candidates have at least $20 million in annual revenue -- in part because fewer companies qualified. More and more buyers are now willing to consider $10 million or even $5 million. Andrew Cagnetta, CEO of Transworld Business Brokers in Fort Lauderdale, Fla., reports that in the past five years individual buyers from around the world have started to check out businesses advertised by his firm on the Internet. They arrange to come here, and if they like what they see, they apply for a visa on that first trip, buy the business, and move here. Cagnetta cites Venezuela, Colombia, Canada, and Great Britain as some of the most common homelands of these new immigrants. In addition, says Phil Steckler, a principal with business brokerage Country Business in Brattleboro, Vt., a tight job market means that lots of downsized-out-of-a-job executives are looking for businesses to buy and run. Given the way private equity firms and their funds have multiplied, however, the odds are much better than they were five years ago that a buyer will be a company rather than an individual.

Even if you're not interested in selling your business right now, it's a good idea to put your company through a valuation process regularly (see "Judgment Day," page 69). You can even do a self-valuation; that's what Kelly Flatley and Brendan Synnott, owners of Bear Naked Granola, do quarterly (see "Maximizing a Company's Value," below). They would eventually like to sell a majority stake in their business, but because they're in no hurry, they can afford to wait for the perfect fit and the right price. Meanwhile they can hone their strategic plan and continue to grow.

"There's a ton of private equity with a fuse on it. You've got pent-up supply and pent-up demand coming together."

Right now, service seems to be the hottest sector. If you turn to the "Trends by Industry Group" charts on page 78, you'll see that multiples for service businesses jumped in 2003 -- meaning sellers at service businesses got a higher price per, say, net income or cash flow than they had in recent years. An example from Stanley Feldman, chairman of independent valuation firm Axiom Valuation Solutions and associate professor of finance at Bentley College in Waltham, Mass., shows how some service businesses are making the most of the improving economy. Medical practices, Feldman says, might sell for a lower multiple than dental practices (our data shows the opposite, see page 81). The difference, he says, is that dentists have the greater ability to go after discretionary spending by encouraging, say, whitening, straightening, or cleanings four times a year. Doctors are much more dependent on insurance and on the political pressure to keep health care costs down. "They're trying to pay doctors less and less money," says Cagnetta of Transworld Business Brokers. "So as doctors are bringing in less and less money, people aren't buying doctor practices the way they used to."

Retail and wholesale businesses also saw healthy increases in multiples last year. In particular, several business brokers and private equity executives report that food distribution is hot -- especially small ethnic and natural food distributors, which are being snatched up by larger companies as their fare continues to grow in popularity.

By contrast, manufacturing has drifted, with multiples of earnings neither rising nor falling much. But buyers are paying much less for book value. "There's tremendous discomfort with domestic manufacturing because of outsourcing overseas," says Bill Landman, chief investment officer at CMS, a Philadelphia investment firm. "A lot of people that used to concentrate on domestic manufacturers are trying to buy them for less." Buyers don't want to pay a lot for costly production facilities in the U.S. When they do make a purchase, there's a good chance they'll move the plants overseas.

Current owners of manufacturing concerns are doing the same. "Companies that can move quickly and adopt new market economics will receive higher multiples," says Linn A. Crader, president of Crader & Associates, a mergers and acquisitions boutique in Lake Oswego, Oreg. "And companies who don't move or stay with the old economic ways of doing business will decrease in value." This may well mean outsourcing production to someplace like China. It could mean "componentizing" -- having other, most likely foreign, manufacturers make your components, assembling the components at your own offshore facility, and selling the completed product here at a price below what it would have cost to manufacture it here. Companies with annual sales of as low as $20 million now need to consider these measures, says Crader. And this doesn't apply just to manufacturing. If services are your thing -- processing health or benefits records, for example -- you can batch them here, send them to India overnight, and have them back in the morning at 20% of the cost of doing it all here.

A word of caution when it comes to comparing business valuations: Many participants in private markets say obsession with multiples is unwise. "Value is in the eye of the beholder," says David Malizia, managing director at Florida Capital Partners, a Tampa-based private equity firm. Malizia believes that many valuation experts take an overly technical approach to their craft that's inappropriate for private businesses, the most illiquid of all the markets. Malizia compares selling a business to selling a house. "If you sold your house at $200 a square foot, and your neighbor wants to sell his house, he might want $200 to $205 a square foot. But the houses are not the same. It's not the same floor plan; it's not the same decoration; it's not the same landscape. Too many business owners think that if that business over there sold at that multiple, I should get the same multiple. But there are different management teams; there are different product lines; there are different profit margins; and there's a different emphasis on strategies and tactics."

"I'm a three- to five-times cash flow valuation man."

On the other hand, if you're looking to sell a business, you've got to watch out for people who tell you not to pay attention to multiples. "Sellers should recognize that buyers are obviously trying to come in and get it at the lowest possible valuation," says Steven Rogers, clinical professor of management and finance at Northwestern's Kellogg School of Management. Rogers recommends that sellers use the discounted cash flow model, which forecasts the amount of cash a company will be able to throw off in future years, then derives a present value from that prediction. Interestingly, Rogers likes the technique precisely because of the uncertainties involved in making future projections and the flexibility those uncertainties provide. Unlike Malizia, Rogers is a believer in multiples as eternal verities. "I'm a three- to five-times cash flow valuation man," he says. As he explains in his book, The Entrepreneur's Guide to Finance and Business, in a typical deal, in which a buyer finances 75% of the purchase with debt, he expects to be able to pay off that debt in five to seven years. That means he shouldn't be willing to pay more than five times cash flow for a business.

Another important part of the value equation is you, the owner. How long are you willing to stay on as a manager and a minority owner so you can transmit your unique feel for the business? Crader says an ideal seller is an owner in his mid-fifties who is willing to stay on as a manager with an equity stake for three to five years. But Jester tells those owners really interested in getting out not to worry, that he's got plenty of people ready to take over "if somebody says it's time to ride off into the sunset."

In any case, now is a good time to consider selling, and now is always a good time to value your business. The process means considering multiple variables and running multiple scenarios. Potential buyers may emphasize the more pessimistic assumptions and outcomes, but they may also be able to create grander strategic plans than you ever could imagine with resources and connections you didn't know existed. Good business brokers or independent appraisers should be able to do the same.

Sidebar: Maximizing a Company's Value

Last year, a venture capital firm eager to invest approached Bear Naked

Granola in Darien, Conn. Instead of jumping at the chance, the cereal makers stopped in their tracks. "I had no idea how much the company was worth," says founder Kelly Flatley. But she and co-CEO Brendan Synnott recognized that the stronger portrait they could paint, the more cash they might get.

Instead of paying a high fee to a business valuation expert or allowing outsiders to tell them their own story, Synnott and Flatley do their own valuations. What they've learned in the process has changed the way they do business. For example, the co-chiefs quickly realized they lacked accounting data, so they retained a CPA and bought new accounting software to track every dollar made in real time. In addition, Synnott says, the process compelled him to scrutinize cost of goods, a former weakness for the company.

When they looked at their books through the lens of the retail industry, they found that valuation multiples in retail had fallen below those in wholesale or gourmet brands. Those categories proved more fitting for a company that bakes at least 4,000 pounds of cereal a day and moves a majority of its product through groceries such as Stew Leonard's and Whole Foods. Their next challenge, in terms of showing the company's worth, is a happy one. "We've gotten into some big accounts based on our performance and solid relationships with smaller or initial customers," says Flatley. "Those aren't on our ledger yet. But they're definitely a part of our value." -Lora Kolodny




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