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I feel like I still work with my family – just globally. But in addition to working in the industry, I also have an MBA with a specialisation in finance and experience in an investment bank doing equity research and strategic advisory. So I have a unique perspective on the industry. A shop owner said to me recently: “You can talk about finance and capital markets and in the next breath we can be talking about p-pages, repair methodology and shop layout. It’s crazy!”

Because of this unique perspective, I often hear comments and assumptions made from those within the industry that make me cringe. At best, these comments can cause real harm if left unaddressed, and at worst can be used by savvy buyers to mislead a seller. These are the five most common misconceptions I hear when talking with clients considering a sale.

“I DID $6 MILLION IN SALES LAST YEAR, SO THAT MEANS I’M WORTH AT LEAST $5.5 MILLION. OH, AND I HAVE A FIVE-WEEK BACKLOG.”

The value of a business is based upon cash flow. Not sales and certainly not backlogs. Sure, generally higher sales can lead to greater cash flows, but that is far from certain. There are a lot of things that can impact cash flow. Before I can offer a realistic opinion on value, I have to see the cash flow.

An important part of justifying a premium price to a buyer is to build out a projected cash flow statement that demonstrates the growth potential of the business. Known as a DCF model, this financial model looks at the future performance of the business and converts the future value to present.

I spent a lot of time in business school building DCF models and they can become complex quickly. I build them for clients now and they are time consuming. But they are essential to the business sale process.

If you’re at maximum capacity and booked five weeks out though, it is difficult to make a compelling case to a buyer that there is room for growth. Just hire another tech you say. If it was so easy, why haven’t you already done so? Which brings me to my next point.

“I’M WORTH MORE BECAUSE I HAVE SO MUCH EXTRA CAPACITY.”

The new owner will easily be able to double my current sales. Having upside is great. But a business with 50 per cent excess capacity not so much. Underperformance comes from many areas – outdated equipment, poor management, unmotivated staff, etc. As a buyer, why would I pay a premium for your underperformance?

If it is so easy to double sales, get out there and do it first. Then take your business to market.

“I’VE BEEN WORKING IN THIS BUSINESS FOR 30 YEARS. SWEAT EQUITY DOESN’T COME FREE.”

This may hurt to hear, but your sweat doesn’t matter unless it produces cash. A business is not a classic car that appreciates with value the longer you own it. If you want to create value in your business, i.e. goodwill that a buyer is willing to pay in excess of the value of your assets, you have to create a business with systems and processes that allow for sustainable future earning potential.

“WHY WOULD I SELL AT FOUR TIMES EBITDA? IF I STAY IN THE BUSINESS FOR FOUR MORE YEARS I’LL BE AT THE SAME SPOT AND STILL OWN MY BUSINESS.”

This one is one of the more frustrating ones I hear because it is flat out wrong. It stems from a lack of understanding of fundamental financial principals (or reality). First and foremost, EBITDA is not cash flow to the equity holder (i.e. business owner). Interest and taxes are very real cash expenses, and after factoring these in, it could take as many as 10 years or more for a business owner to “break even” to reap the same benefits as a business sale.

For example, if a business is generating $1 million in EBITDA, is offered a purchase price of $4 million, the after tax proceeds on a sale (assuming a 30 per cent tax rate) are $2.8 million. Compare that to the present value of $4 million over four years. Assuming a 30 per cent tax rate and an 18 per cent discount rate (a conservative assumption indeed for a small privately held business), the present value of those cash flows are only $1.88 million.

Yes, you’ll still own your business at the end of that time horizon. But it will have cost you $1 million. And there is no certainty your business will be worth four times at that point. As quickly as prices have risen in the past three years they can also fall as quickly. But if you sell it today, you’ll be holding more money and carrying none of the risks that come with holding the business with the freedom to reinvest the proceeds from the same into other more attractive ventures. This is exactly why people sell their business.

“I DON’T NEED AN M&A ADVISOR. MY LAWYER IS GOING TO REPRESENT MY INTERESTS.”

You could also do the same thing when selling your house. The forms required to sell a house are standard in most advanced economies and could be completed cost effectively by many an attorney. But rarely does that happen.

Business sales are anything but standard. They are incredibly complex and time consuming. Attorneys are critical for legal review, tax experts for tax guidance. But M&A advisors shoulder a significant portion of the complexity of getting a deal done efficiently and at the best price and terms.

At a very basic level, M&A advisors provide a realistic assessment of value based on actual market conditions. Industry specific advisors, while maintaining confidentiality, can point to trends they see from specific industry experience in a way that even the most experienced attorneys, tax advisors or accountants cannot.

But the most powerful and unique role of an M&A advisor is the ability to create an auction environment. An auction environment, whether real or perceived, drives buyers to pay maximum value for your business.

In an auction scenario, the advisor and seller have invested heavily in prep work known as seller due diligence before going to market. Because the advisor has run a professional M&A process previously, a buyer knows the seller is a serious seller and is motivated to pay full price for the business for fear of losing out on the opportunity to a competitor.

What do you think? Have you experienced any of these situations? If so, I’d like to hear from you. I’m also interested to hear from you if you are looking to grow as well.

This is an article that appeared in Paint and Panel Sep / Oct 2016.

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