Once a business owner has decided to sell their company—and have worked with professional advisors to determine the best sale structure—the next step is to value the business.
The right valuation can help the sale process go more smoothly and help the seller set realistic pricing expectations for the transaction.
Coming up with the business’s valuation can be difficult for many owners, given their often deep and personal connection to the business.
“Great owners have poured their heart and soul into building and expanding a business; there’s a large emotional value from that which can be very difficult to get away from during a sales transaction,” says Mark Chan, a vice-president of wealth planning at Gluskin Sheff.
It’s why coming up with the business value can be the hardest part of the sale process for owners, many of whom may believe the price should be higher than the fair market value.
“It can be one of the biggest hurdles in the process and a difficult conversation,” Chan says, “but it has to be done. You need to have a good idea of what you can realistically expect to sell for in the market given current conditions and available and willing buyers.”
Valuation by numbers
The right price for the business is often determined with the advice of professional valuators who look at key performance metrics such as normalized earnings. Other factors that can affect the business valuation also include current industry and market trends, intellectual property and technology used in the business and key employees of the business.
“Normalized earnings are what the business could realistically expect to earn in future years on an annual basis,” Chan says, adding, those expectations may be adjusted for one-time extraordinary events, such as the pandemic, weather-related events or capital improvements.
Chan says a valuation specialist will also determine what multiple should be applied to the business earnings.
A higher multiple often reflects a lower perceived risk to future earnings because the business is able to generate strong, growing, reliable cash flows
A business in a strong industry with competitive advantages and barriers to competition will also have a higher multiple. Strong management also helps.
“A higher multiple suggests that the business could be worth more,” Chan adds. “Conversely, the business can be worth less with a lower multiple if there is some industry uncertainty, such as concerns about supplier disruptions or other business interruptions down the road.”
Getting the business in shape for a sale
Before hiring a business valuator, business owners should ensure they have complete documentation and financial statements to support the business’s historical profitability and articulate the value of the company, Chan says. For instance, companies with a demonstrable strong corporate culture and customer and supplier engagement will often be more attractive to potential buyers, particularly in the current market environment where corporate responsibility is front and centre.
During this internal review process, the business owners may identify areas of improvement within the business that could negatively impact the business valuation, such as financial reporting processes, cost structure and compliance with the tax authorities. It is important for owners to work with their professional advisors on such issues before speaking to potential buyers in order to avoid surprises later on in the sale process.
Owners should also determine if they plan to remain involved in the company post-sale to ensure a relatively smooth transition, which can also help maintain its brand and culture and potentially boost the business’s valuation.
“A business is often worth more when the buyer knows that there will be fewer disruptions and strong continuity,” Chan says. “Also, properly communicating that continuity to future owners, management team suppliers, and key stakeholders is an important component of a sales process.”
Jonathan McMurrich, a senior wealth planner at Gluskin Sheff, says sellers should consider getting ahead of any issues that could come up during the buyer’s due diligence. This approach can help establish a good-faith and transparent approach to the transaction, while also allowing the seller to position any issues in the best possible way.
And while selling a business can be a distraction and time-consuming for owners and senior management, sellers need to ensure the operations continue to run well so the valuation isn’t affected.
Strong advisors help make the sale a success
McMurrich suggests sellers should engage experienced mergers and acquisition professionals to help them navigate through the sale of the business.
“Good advisors should be able to help the business owner articulate critical aspects of a sale such as the company’s value proposition, the competitive advantage, and why this is an opportunity for a buyer,” he says.
Professional advisors can also help sellers pick the best buyer. Sometimes owners don’t choose the highest-priced offer, but instead the buyer that’s most likely to maintain the brand or maintain key employees who have contributed to the company’s success
Lastly, advisors can help ensure sellers have an updated wealth plan that will guide them on what to do with the after-tax sale proceeds in the next stage of their life. For example, the proceeds could be used to start another business, take some time off, or retire—all of which would require wealth and estate planning catered to the owner’s individual post-sale plans.