what is your company worth?

SOMETIMES THE BEST THING YOU CAN DO FOR YOU --AND THE COMPANY YOU FOUNDED--IS TO PLACE IT ON THE AUCTION BLOCK. THE KEY IS GETTING THE TRUE VALUE OF YOUR ENTERPRISE.

YOU'VE DECIDED TO RETIRE TO THE GOOD LIFE YOU WORKED so hard to secure. Or perhaps big business has moved in on your turf, making it harder to compete in your market. Maybe you need to raise capital for a new venture. Whatever the reason, the decision to sell your business will probably be one of the biggest you will make, and one that financial experts say should be carefully planned for at least a year.

The big concern for business owners is figuring out just how much their company is worth; in other words, "How much can I expect to get for my years of hard work?" To improve the chances of getting what you think is the true value of your business, you should take some key steps in preparing the business for the market.

HAVE AN EXIT STRATEGY

"Every business needs an exit strategy. There should be a strategy for a planned exit and a disaster plan," says Bob Besten, managing broker at the Lexington, Kentucky, office of VR Business Brokers. "When you ask many business owners what happens if they die, you get no answer," says Besten. But in the event the principal cannot continue in the business, whether it's for professional or personal reasons (like health issues or a disagreement with a partner), the value of the company could quickly deteriorate. Exit strategies and succession plans are critical. A plan better positions the owner to receive a desired value in the event he or she wants to sell the business. A sound exit strategy might include plans to turn the business over to a trusted relative or a senior person in the company who could continue to run the entity should you not be able to. Another strategy would involve hiring a professional advisor in preparation for the sale of the business.

GET YOUR HOUSE IN ORDER

A buyer's confidence in your company's financial statements is critical in selling your company. One of the first things many financial experts and entrepreneurs who have successfully sold businesses advise is getting the financial statements of your business in top shape before putting it on the market. "You should have audited or at least reviewed financial statements by a CPA for the past few years," says Robert J. Jordan, senior partner at Los Angeles-based Knowledge Management Systems L.L.C., a technology company that specializes in automated workflow and technology applications. Jordan found having quality financial statements crucial in getting his desired price in 1999 when he sold his fulfillment-distribution company to a former division of Fisher Electronics. Jordan would not disclose details of the sale, but says he sold it for a "high seven-figure" amount.

In order to get a more accurate financial picture of their business, Jordan suggests owners "restate financial statements to exclude any of their personal expenses that may have been run through the company." Jordan stresses that the buyer usually sets the terms of the documentation required during the buying process. "The buyer required three years of tax returns, a 12-month pro forma statement, a cost and revenue analysis of the top five customers, an operational study illustrating the labor cost for three different product types, six months' bank statements, and a break-even analysis," he explains.

With regard to the type of statements delivered, Jordan says, "My statements were not audited. Although it is helpful to have audited statements, it is usually cost prohibitive for small companies. So small operators usually resort to reviewed statements instead. This still entails an independent third-party review, but it's just not as detailed."

Adds CPA Karl Planer of the Los Angeles-based Planer Group, "Reviews are less comprehensive and far less detailed than audits." He adds that accounting fees for small to midsize CPA firms typically start at $100 per hour and are about $300 an hour for partners. An audit could end up costing a small business anywhere from $5,000 to $10,000, depending on the nature of the business and the number of transactions; the accountant would be required to audit all transactions. Brian E. Argrett, president and CEO at Fulcrum Venture Capital Corp., a Culver City, California-based private equity firm that targets minority businesses, also advises sellers to be able to provide, in addition to audited or reviewed statements, three- to five-year financial projections with reasonable assumptions, along with tax records. "Reasonable assumptions" means that assumptions for sales growth and expenses should be consistent with how the company has performed historically. Major increases in sales growth and other deviations from past performance could be viewed as unrealistic and overly optimistic. If the assumptions used are based on historical averages, it would be reasonable to exclude onetime past items that one would not expect to see repeated in the future. This will present a more normalized projected performance.

Karl W. Planer, a CPA with the Planer Group in Los Angeles, recommends that sellers proactively clean up their financial statements before putting the company up for sale. "You may want to discount aged receivables or write off some receivables to clean up your books. The more favorable your statements, the less negotiating you have to do with your price," he says.

Argrett and Cedric Penix, Fulcrum's principal, also urge sellers to make sure their legal files, board minutes, leases, and contracts are in order before embarking on a sale.

HIRE A PROFESSIONAL

Unless you have the skills and the time to take your business to the largest pool of potentially qualified buyers, your best bet is to hire a professional. Depending on the proposed value of your business, that person could be an investment banker or a professional business broker. In any case, you should hire someone who can best present the company to the marketplace and maintain confidentiality.

"For companies valued between $10 million to $100 million, you are usually looking at hiring a boutique or middle-market-focused investment bank," says Willie E. Woods, a former investment banker with Deutsche Bank Alex Brown and now a partner at ICV Capital Partners, a New York-based equity fund. David T. La Velle, a financial consultant in the Merrill Lynch Private Client Group, says that for businesses valued in the $10 million to $50 million range, Merrill's mergers and acquisitions advisory team would handle the client. Businesses valued between $50 million to $500 million would fall in the firm's sales and divestiture group, and companies with more than $500 million in value would be handled by the firm's investment banking division.

When choosing an advisor, Woods says, "Hire someone who has lots of experience selling your kind of business--both in size and in industry. You also want a senior person in the firm handling your transaction. You want to be a priority. A junior person may not have the experience you need." Woods says a good banker will have a list of potential buyers to create a competitive auction for the business and a list of recent deals.

For companies valued at less than $10 million, a professional business broker might serve as a good sales representative for your company. Typically less sophisticated than investment bankers, brokers usually work on commission.

Besten, who primarily represents companies valued at less than $5 million, says a seller should interview a potential broker and investigate important characteristics like competence, trustworthiness, familiarity with the industry and its current trends, markets of operation, and length of time in business. Besten emphasizes that credentials like a CPA, a law degree, a real estate license, or a securities license are also important. Sellers should also check the broker's reputation with the Better Business Bureau.

Argrett and Penix also suggest that a seller secure an attorney familiar with issues pertaining to selling a business. Your family lawyer may not suffice. An attorney will be essential for drafting all documentation, including the purchase agreement, to hopefully prevent any litigation down the road. A good tax advisor is also recommended.

THE ART OF BUSINESS VALUATION

After all of your long years of sweat, you want to get back all of the work you put into the business. "There is so much emotion involved in selling a business, it can sometimes result in unrealistic expectations for a seller, says La Velle. "Sellers must be realistic."

"The trouble with valuation is that there is no true science to it. It's more of an art," says Jordan, who, subsequent to the sale of his fulfillment company, sold a business-to-business vertical trade portal aligning Asian manufacturers and U.S. retailers to Lazard Freres & Co. L.L.C., the investment bank, for $900,000 in cash and stock options.

"Venture capital firms were eager to invest in the new economy and we happened to be in the right place at the right time," says Jordan.

"All valuation methods are flawed. At the end of the day, your business is worth only what someone is willing to pay you for it," says ICV's Woods.

According to La Velle, the industry uses three simple valuation methods (see sidebar for descriptions). To receive the highest value possible for a company, instead of listing a company for sale at a predetermined price, a seller should consider allowing the representative to present the business to the open market for bidders. "The bid option gives the seller an opportunity to witness the demand for his business. Assuming the business is worth $15 million and the seller wanted between $18 million to $20 million, the open market might actually present bids from $25 million to $45 million, allowing the seller to receive a premium far above expectations," says LaVelle. A buyer's willingness to pay a substantial premium for a business could reflect a strong desire to enter a certain market or industry, or the value associated with vertical or horizontal integration.

Penix says Fulcrum commonly uses a multiple (a numeric factor) times company earnings to determine the value of the companies in which it invests. Earnings are typically measured by earnings before interest, taxes, depreciation of capital equipment, and amortization of intangible assets like goodwill and intellectual property (known in accounting terms as EBITDA). A more conservative method would include EBITDA less any capital expenditures for items like machinery and equipment required to maintain the business as a going concern. Under this scenario, the resulting number is typically called free cash flow.

"To find multiples of comparable companies, sellers can ask their broker, other sellers, or scour the newspaper for deals of public companies. Sellers can look at deals of public companies as a proxy but must adjust for size and other factors," says Argrett. Jordan used industry trade journals and investor services such as Moody's and Valueline to provide a benchmark for cash flow multiples for his industry, as well as comparisons to similar businesses.

But valuation models do not always tell the full story. In valuing New York-based Amistad Press in preparation for its sale to HarperCollins in October 1999, Charles Harris, vice president and executive editor of HarperCollins and editorial director of Amistad Press, says, "We started with cash flow multiples [as a valuation method], but that method valued the company abnormally low because we had not had the cash to adequately promote our books." Amistad had published several bestsellers, including John H. Johnson's Succeeding Against the Odds and Susan Taylor's In the Spirit. HarperCollins ultimately determined a confidential method for valuing Amistad that Harris was comfortable with. This was a factor that actually motivated Harris to sell the company he founded in 1986.

FULL DISCLOSURE AND DUE DILIGENCE 

The old adage "honesty is the best policy" holds true when selling your company. "The worst thing to do is to try to hide something from a buyer," says Justin H. Sanders, a mergers and acquisitions attorney in the Los Angeles office of Sheppard, Mullin, Richter & Hampton L.L.P. Sanders warns that misrepresentation of your business could result in future lawsuits from the buyer, particularly if it concerns factors related to valuation. Woods adds, "Because the process to sell a business can take six to eight months, time will expose any dishonesty and inaccuracies."

Once a buyer agrees to purchase your company, there will be an escrow period that usually extends from 30 to 90 days. During this period, the buyer will conduct a full review of your operations before closing, so it is imperative that you cooperate with the buyer. "My buyer wanted to talk to 90% of my customers, particularly the large and most important ones. They looked at my financial statements, talked to my accountant, looked at my bank statements, talked to key employees, and oversaw my productions to see the physical evidence of what was represented on paper," says Jordan. Such scrutiny is common, and Jordan's sound preparation contributed to his receiving the price he wanted for his company.

THE TAX MAN COMETH 

A major consideration for a seller will be the type of transaction to enter into for the sale. "An all-cash sale could result in a tax liability on the capital gain in the transaction," says Planer. "However, a transfer of like-kind assets may not be a taxable transaction." For like-kind asset transfers, assets must fall in the same asset class or product class to prevent any taxation on the transfer. For instance, you can't exchange a crane for office furniture. Planer also states that sellers might consider stock-for-stock transactions, which do not immediately create a taxable transaction. "In order to defer taxes, instead of receiving all proceeds from the sale up front, a seller may choose to make an installment sale, thereby spreading any capital gains over a period of time," says Planer.

Another transaction method to consider is the earned payout method, whereby the buyer retains a seller for consulting or other future services. This situation would be common, for example, when the seller's departure could result in customers defecting. The seller would usually stay on board for a consulting fee in order to assure a smooth transition. "A seller needs to decide how much involvement he wants after the sale," says Argrett. A consulting arrangement gives the seller a vested interest in the company and gives the buyer confidence that the seller will be available to advise the new management team on key issues. Under these circumstances, a portion of the purchase price is usually paid to the seller as a consulting fee over time, which also allows a deferral of taxes.

Selling your business for the value you want will require diligence on your part: keen financial planning and financial statement preparation, solid advice from qualified professionals, your honesty about your business, and your willingness to be realistic about the value of your company.

Selling a Business

there are three simple methods of valuing a company:

Method #1: Asset valuation

Fair market value of fixed assets and equipment This is the price you would pay on the open market to purchase the assets or equipment.

Leasehold improvements. These are the changes to the physical property that would be considered part of the property if you were to sell it or not renew a lease.

Owner benefit. This is the seller's discretionary cash for one year; you can get this from the adjusted income statement.

Inventory. Wholesale value of inventory, including raw materials, work-in-progress, and finished goods or products.

Method #2: Capitalization of income

This method places little or no value on fixed assets such as equipment, and takes into account the number of intangibles. This valuation method is best for nonasset-intensive businesses like service companies. Some of the variables that should be considered are:

* Owner's reason for selling

* How long the company has been in business

* How long current owner has had the business

* Degree of risk

* Profitability

* Location

* Growth history

* Competition

* Entry barriers

* Future potential for the industry

* Customer base

* Technology

Assign each factor a rating between zero and five, with five being the most positive score. The average of these factors will be the "capitalization rate," which is then multiplied by the purchaser's discretionary cash to determine the market value of the business. Next, determine a figure for "purchaser's discretionary cash," which is 75% of owner's benefit. Finally, multiply the two to determine the market value.

Method #3: Multiplier or market valuation

This approach values the business by using an "industry average" sales figure as a multiplier. This industry average is based on what comparable businesses have recently sold. As a result, an industry-specific formula is devised, usually based on a multiple of gross sales. This is where some people have trouble, because they often don't focus on bottom-line profits, cash flow, or how different two businesses in the same industry can be.

Examples:

* Travel agencies -- .05 to 0.1 X annual gross sales

* Ad agencies -- 0.75 X annual gross sales

* Retail businesses -- 0.75 to 1.5 X (annual net profit + inventory + equipment)