The old adage of “buy low, sell high” endures as the single best piece of sales advice to this day. However, the devil is in the details — specifically, how buyers can try to bring down that sales price, and how sellers seek to raise it. But one thing is certain: Settling on the ideal valuation for your business can be tricky.

Valuation Methodologies

Entities can be valued in different ways. No technique is intrinsically better than another, but the chosen valuation method and key underlying assumptions will impact the end result.

The most common technique is the income approach — of which the most common application is the discounted cash flow method — which values the entity based on its future cash flows. Forecasting models help estimate future cash flows, which are then discounted back to present values at a risk-adjusted discount rate.

Another common valuation method is the market approach, which compares the target’s financials to those of similar companies. Buyers will look at statistics such as price-to-earnings (P/E), earnings before interest and taxes (EBIT), earnings before interest, taxes, depreciation and amortization (EBITDA), and price-to-revenue (P/R) multiples. Recent sales and mergers and acquisition transactions can also provide insight. The market approach reflects market volatility, so this should be considered when using it.

The third common valuation method is the cost approach. This approach focuses on the balance sheet in determining the value of the entity by estimating the value of the assets and subtracting the liabilities. The cost approach can be a great starting point, but intangible asset values such as goodwill, technology or customers are generally not included. The cost approach is typically used for early stage companies or asset-holding companies that may not have created intangible value yet.

Value Through a Buyer’s Eyes

To position your business for a strong valuation, consider your intended buyer. Venture capitalists (VCs) typically look to monetize their investments by exiting in as little as three to five years. As a result, VCs typically place a high value on the potential target’s growth potential from a revenue and EBIT/EBITDA perspective. VCs really focus on the target’s projected performance, cash flows and expected revenues as opposed to the historical performance of the business.

Corporate buyers are more likely to take a long-term approach to their investment. While they will also review the target’s past and future financial performance, growth may not be the prime driver of the sale. Instead, you may be able to entice corporate purchasers with your consistent (and repeatable) sales or enviable market share. The key factor here is what your firm can offer the acquirer, which may involve technology, cash flow and/or time to market advantages.

To showcase your best assets, you should reconcile your tax strategy and your financial results to provide the most accurate financial statements. Is your income statement normalized, or is it impacted by large tax deductions? Accelerating depreciation, for instance, can minimize a company’s profits for the year. Closely held entities often try to minimize taxes versus maximizing profits. They may incur expenses that deflate profits, therefore lowering their tax liability. But when you’re looking to be acquired, profitability must be embraced. By making a few adjustments to your tax strategy and/or your operating strategy, you can boost your profitability to entice potential buyers.

What to Do to Prepare for a Buyout

As you prepare to be acquired, consider the ways you can maximize your sales price. Understanding your company and your financial results may result in the selection of a certain valuation method, but it’s more important to see the big picture.

• Know your financials.
  Analyze your financials from a different perspective. Prepare them using a different accounting method or by employing a different tax strategy and see what you get. To do this, you can work with your accounting team directly, or you can hire an outside valuation firm.
• Know the buyer.
  Understand your buyer’s motivations. Are they interested in your future growth or does the buyer want your employees and operations for the market expertise? Align your sales pitch and financial reporting decisions with the buyer’s wants and needs.
• Know what you want.
  Do you want to keep working? Do you want to exit the business? Do you want the money up front? Do you want reliable revenue in the future as a passive investor? Be clear about what’s important, as well as where you can compromise, and be prepared to stand firm on your non-negotiables. Consult with your tax advisor to structure a deal that is the most tax advantageous.

See the Big Picture

Value is never determined by a single line item on the income statement. For that matter, it is rarely determined by numbers alone. Corporate synergies, operational efficiencies, and buyer and seller motivations all factor into the final valuation. As you consider a merger or acquisition, look at the big picture. Preparing in advance and keeping yourself focused on your goals will help you achieve the best possible outcome.

March 14, 2019