Simple Solutions That Work! Issue 15

Continued on next page CASE STUDIES 41 who are low margin or are constantly late with payments. Weeding the garden will help your appraisal value. Operations like an advertising agency, technical consultancy, or legal firm where the owner is the business can be harder to valuate, but generally rely on the same strategies. Putting the value on the business goes far beyond the old “1x revenue” or “3x profits” methodology for educated buyers. One metric used is the Seller’s Discretionary Earnings (SDE), which is the “Seller’s Value”. The Seller’s Value is the net income (EBITDA) of the business plus “add backs” such as operator’s salary, frequently used assets that are in the name of the business but are not necessarily part of the sale. i.e., company cars, planes, season tickets, and other fringe benefits. These expenses are items that the buyer can forgo and reinvest if they choose. The value paid may also be adjusted down to account for replacement salaries for team members that the buyer will have to hire. Owner Operators who are also the President/VP of Sales/ GM/Maintenance manager may fully justify the amount that they take home at the end of the day – but a buyer will need to hire people to fill the current owner’s shoes. These replacement salaries get deducted from the business value, since the buyer must hire staff for the business to succeed. Hiring and training professional managers and team member to replace the owners is a valuable investment. These team members can ensure the future value of the company is uninterrupted after the owners exit. Taking the burden of finding and training critical staff off the buyer will increase the business value. Buyers will want to see what your team looks like as well. What percentage is about to retire, how much of the staff is well experienced and in their prime, and who’s still wet behind the years. A buyer doesn’t’ want to see a thirty-year-old company with no employees having more than a couple year tenure. That’s a sign that they may end up being owner- fork truck operators themselves. Assets such as real estate, inventory, and supplementary (in-house) product lines can increase the value of the business – however be prepared for the fact that they may be handled as separate transactions. A buyer may want to hold them as separate entities or may want to split them out and only buy the business but not the facility, or the product line. Some buyers advise running the product line either as a discrete P&L center or as an independent entity to maximize the amount that they will pay for the total package. If you have good clean financial and environmental documents on a building, the buyer can make a clear decision on whether to buy the facility, lease it from the seller, or just move out completely – leaving the seller with a building to either rent out or sell to someone else. Disposing of twenty years’ worth of unused patterns may let you lease out a warehouse or two in advance of selling the foundry. Buyers, and their banks, frequently will look for the seller to hold some of the value of the sale as a personal note. While the seller may frequently want to cash out, and be done with it, loan payments, milestone based earnouts, and royalties can allow the buyer to pay a higher price and have some insurance that everything bought will continue to perform as promised. Promissory notes to the seller, like bank notes, need to be paid on a schedule or there are enforceable consequences. Milestone based earnout payments are fraught with loopholes and can be risky for the seller. Legally enforcing such agreements can be challenging, or completely impossible depending on the terms of the agreement, and disingenuous buyers can walk away from a substantial portion of the purchase price without consequence. Sellers should use extreme caution in entering earnout agreements. Royalty payments, or earnout payments based on future incomes, are a safer bet for the seller. Paying 5% of future income for 5 years, or similar terms, allows the buyer