Justifying Your EBITDA
All too often a business owner decides to sell, only to learn a number of harsh realities. For example, oftentimes a business owner discovers that their lack of financial data represents a major problem. The simple fact is that prospective buyers will dive in and scrutinize every aspect of EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization) when looking at their perceived value of your business. This will most likely take place through what is called a Quality of Earnings Analysis Report (Q of E). General Accepted Accounting Principles serves as the key basis and language for financial reporting (known as GAAP Accounting). GAAP Accounting and Reports often represent a marked departure for how many companies handle their general and day-to-day accounting. The end result of all this can be a substantial shift in EBITDA as compared to what the actual number really is.
Potential buyers will ultimately receive numerous documents that outline the financial and operational health of your business during what is called the due diligence process in acquiring a business. This means that you, as a business owner, must be ready to invest a good deal of time in the process of disclosing as much accurate information as you can, in support and defense of the true and accurate EBITDA of your business. In short, preparing your business to be sold is no small affair when it comes to making sure that information is fully disclosed and in defense of the actual quality of financial and operational health to ensure the highest and best acquisition price.
EBITDA is one of the most common ways to value a business based on multiples of that number. When engaging your business for acquisition in the open market, you should expect that any buyer or potential investor will perform a review of your income statement for adjustments in order to arrive at an adjusted EBITDA that makes sense for THEM.
You need to be ready and fight back as to what the true Adjusted or Normalized EBITDA is, that serves as the basis for a purchase price of your business creating a value used with a multiple to negotiate a final price and terms that make sense for both parties. Miss out on the correct EBITDA for your business by $100,000 on a 3 multiple and you just gave up $300,000 in acquisition cost of your business – as an example.
There are three common EBITDA adjustments:
- First, items related to conversion based on a GAAP Accounting basis; this number can have a considerable range.
- Second, one-time events such as legal expenses, PPP loan forgiveness, insurance settlements, unusual expenses associated with issues/growth of the business can greatly factor into an adjusted EBITDA amount.
- Third, certain personal expenses a business owner takes that would typically not be part of the future cash flow of your business is another potential impact on EBITDA.
It is important not to ignore balance sheets when it comes to representing the financial health and aspects of your business as well. Smaller businesses typically focus strictly on profit, and this factor can result in balance sheets not being reviewed as often as they should be. A balance sheet needs to be recast in a way that the potential buyer truly understands the assets and liabilities that convey in a sale. It is better to recast the balance sheet upfront to what truly conveys with the business as the end result can be items popping up during due diligence causing hiccups in deal making and negotiations.
As an example – many times we see that business owners may park large amounts of cash in their business and on their balance sheets – over and above what is normally necessary. The minute a potential buyer sees a $1,000,000 cash position on a business when a $60,000 working capital position is needed, they are going to want that $940,000 cash to convey with the business. That’s fine if they are willing to pay $940,000 more for the business but not if they want the sale price of the business on a “cash free, debt fee” basis when the business conveys to stay the same with a reasonable sale price.
The same is true with liabilities. If you intend to convey the business without debt – if $500,000 in liabilities is relieved from the business, the value and burden of debt on the business logically increases by an adjusted amount in cash flow that is not needed by the business moving forward. This mathematically (and logically) increases the value of the business based on the cash flow used against the multiple used for valuation. Relieve $100,000 debt service to the business against a 3 multiple for the value equates to an additional $300,000 in value and price that the business should sell.
There are three key points that business owners should keep in mind when they are planning on selling their business:
- Make sure that managers and key employees are able to step in and run the business during the transition period.
- Review your financials, and get ready for GAAP reporting requirements during due diligence with a potential acquisition.
- Consider having a Quality of Earnings analysis performed with your business before going to market so you truly understand the financial health with your business.
As this article underscores, selling a business is a process with numerous moving parts. Well organized and solid financials – defensible EBITDA and operational health, represents to buyers and investors a sound and well-run business with an owner that is professional and realistic in their expectations.
Bottom line? Even if you believe it will be years before you place your business on the market, it is never too early to begin preparing.
Copyright: Business Brokerage Press, Inc.
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Alternatives for Owners of Eroding Industries
Let’s assume that you own and operate a company that manufactures a product in an industry that is eroding or going downhill. What are your choices or alternatives?
- Run the company as a “cash cow,” resigning yourself to the fact that your industry is slowly declining or is no longer a growth industry. Keep what you are doing profitable even if you
have to increase prices and/or cut costs. - Increase R&D to develop new products.
- Acquire or merge with a competitor or strategic partner.
- Expand geographically.
- Diversify within the same familiar market.
- Sell the company now before there is further erosion in your industry
© Copyright 2015 Business Brokerage Press, Inc.
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Read MoreShould You Be Selling Your Company…Now?
The answer to the question asked in the title is, “It all depends!” There are all sorts of studies, surveys and the like suggesting that as more and more “baby-boomers” reach retirement age, the market will be flooded with companies for sale. The consensus is that with these privately-held company owners reaching and nearing retirement age, the time to sell is now. In one survey, 57 percent of business owners said that their age was the motivating factor for exiting their business. In another one, 75 percent of owners with revenues between $1 million and $150 million stated that they looked to sell within the next three years. Reading all of this information, one gets the feeling that over the next few years almost every privately-held business will be on the market.
While there are always going to be those who feel that Armageddon is coming, or that all of these companies are going to be on the market on the day that baby-boomer owners hit 65, there are some compelling reasons to sell your business now – and some reasons that may compel you to hold off. One good reason for any owner to sell “now” is that it just may be time to “smell the roses,” as they say. After running the business for so many years, “burn-out” is a very valid reason for selling. Many business owners may have, without actually realizing it, let their business slide a bit. You lose a customer or client here and there and don’t make the effort to replace them. Or, you don’t make the effort to check back with the supplier who has promised to give you a better price on an important product or service. It’s too easy to stick with the one you have been dealing with for years, even though you know the price is probably too high.
On the flip side, it is also easy to convince yourself that business is down a bit this year, maybe due to the current economy or recent legislation, likely reducing the value of the company. Maybe waiting until things pick up a bit and values increase would be a good idea. Thirty-five percent of business owners, in one survey, said they were going to hold off selling because they felt their business would continue to grow and therefore, hopefully, also increase in value. Unfortunately, no one can predict the future. New competitors may enter your market. Foreign competition may move in. You may not have the energy or that “fire-in-the-belly” you once had, so the business may slide even further.
You could also point your finger to the tightening of credit and ask, “How is a buyer going to finance the business?” Despite very low interest rates, borrowing money is now more difficult.
There is an old saying that the time to plan your exit strategy is the day you start running the business. Business owners can’t outgrow interest rates, legislative changes or aging. The time to sell is when you are ready to sell. The mere fact that you have read this far may be a sign that now is the time to sell. To learn more about current market trends, what your business might sell for, and what your next step might be, call a professional intermediary.
© Copyright 2015 Business Brokerage Press, Inc.
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Read MoreDeal Structure: Thinking Outside the Box
The price gap between buyer and seller can often prevent a deal from closing. However, if the principals really want the deal to work, and their advisors really want to help, the following ideas might get the juices flowing so that all of the parties involved can think outside the box in order to make the deal work for everyone.
If the seller owns the real estate, let him or her lease it to the buyer, thus reducing the price. Another idea is to have the seller lease the premises to the buyer at a higher rent, thereby reducing the goodwill factor. The seller could also lease the machinery and equipment, again reducing the overall price.
If it is a fast-growing business with a possible big upside, let the seller share in the growth through an override or royalty over a set sales dollar amount. Or, place a fast-growing portion of the business in a separate subsidiary with the seller owning a part of it – and giving the buyer an option to buy that portion.
Let the buyer buy 70 percent, for example, of the business and the right to purchase 10 percent more each year on a set formula, thus reducing the price.
When all else fails, one good way to solve major issues between a buyers and a seller is for them to meet for dinner, just the two of them, so they can talk about how to make the deal work. We also suggest that you always consult with a professional intermediary as experienced intermediaries can offer helpful ideas and suggestions as to what could work for both the buyer and the seller.
© Copyright 2015 Business Brokerage Press, Inc.
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Read MoreWhat Serious Buyers Look For
Obviously, serious buyers want to carefully look at the financials of a company under consideration and all of the other major aspects of the company. However, there are a few other areas that the serious buyer will investigate that sellers may overlook.
The Industry – The buyer will want to take a serious look at the industry itself, the customers, the suppliers, the competition, etc. This investigation will cover the strengths, weaknesses, threats from competition, and opportunities of the potential acquisition. With the growth of the “big box” retailers, much power has shifted from the manufacturer to the retailer. A manufacturer may want to increase prices, but if Wal-Mart says no, it’s a very powerful no.
Discretionary Costs – Some sellers will reduce their expenses in discretionary areas such as advertising, public relations, research and development, thus making for a higher bottom line. However, these cuts will hurt the future bottom line, and smart buyers will take notice of this.
Obsolete Inventory – This is another area that buyers take a serious look at and that can impact the purchase price. No one wants to pay for inventory that is unusable, antiquated or unsalable.
Wages and Salaries – A company may be paying minimum wages, or offering few or low-cost benefits, a limited retirement program, etc. These cost-saving devices will make the bottom line look good, but employee turnover may create expensive problems later on. If the target company is to be absorbed by another, compensation issues could be critical.
Capital Expenditures – The serious buyer will take a very close look at machinery and equipment to make sure they are up to date and on a par with, or superior to, that of the competition. Replacing outdated equipment can modify projections and may affect an offering price.
Cash Flow – Serious buyers will take a long look at the cash flow statements and the areas that affect them. The buyer wants to know that the business will continue to generate positive cash flow after the acquisition (i.e.: after servicing the debt and after paying a reasonable salary to the owner or general manager).
Other areas that sellers overlook, but that the serious buyer does not are: internal controls/systems, financial agreements with lenders, governmental controls, anti-trust issues, legal matters and environmental concerns.
© Copyright 2015 Business Brokerage Press, Inc.
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Read MoreImproving Your Prospects for Selling
According to a Price Waterhouse Coopers survey of more than 300 privately held U.S. businesses that have been sold or transferred, the most common steps companies take to improve their prospects for a sale, prior to taking the company to market, include:
- Improving profitability by cutting costs
- Restructuring debt
- Limiting owners’ compensation
- Fully funding the company pension plan
- Seeking the advice of a consultant or intermediary
- Improving the management team
- Upgrading computer systems/processes
© Copyright 2015 Business Brokerage Press, Inc.
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