What Is My Business Worth Today?
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What’s the one thing that almost every owner of an independent HVAC company has in common? It’s the continuous curiosity about what his or her business is worth – but without a reliable way to figure things out.
That’s probably not too much of a surprise – after all, if you’re like most owners, you’ve put years of sweat equity and seemingly countless dollars into your business – it’s only natural to think about whether all that investment has yielded any return. But since you’re a contractor, not CPA, generating numbers on your own seems about as likely as your tax preparer’s chances of fixing a broken condenser.
Still, there are some things you can do to give yourself a general sense of your company’s value – and even more things you can do to help a professional give you an accurate understanding of what your company’s fair market value might be.
It all begins with understanding what ‘fair market value’ actually means. The legal definition is that it’s “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of the relevant facts.”
Of course, as a practical matter, there’s always some degree of compulsion involved with a sale – owners reach retirement age and can’t keep the same 80-hour work week anymore, couples get divorced, children move away, neighborhoods change their demographics, and more. All of these can influence just how eager a buyer is to find a willing purchaser.
The same goes on the buying side. There are companies that need to make acquisitions to satisfy a growth strategy, to capitalize on market dynamics, to make use of cash on hand and, well, the list goes on.
Regardless of motivating factors, the valuation used for the sale – at least for profitable companies – will be based on multiples of EBITDA. That’s Earnings Before Interest, Taxes, Depreciation and Amortization, and it’s chosen because it gives the user a sense of what cash flow the business will generate. Things like taxes, depreciation and amortization aren’t really part of the ongoing business, so by looking at the earnings before they’re factored in, the purchaser gets a truer sense of how the enterprise can be expected to perform.
Equally important is that to sell a business, its assets need to be free and clear, so a portion of the proceeds will be used to pay off debt. Without any debt, the interest expense goes away, so it wouldn’t make sense to calculate it into the company’s value. Similarly, cash flow for depreciation and amortization will have already been made, and taxes will be determined by the new owners, so none of these would be considered when calculating value.
What will be considered is the company’s track record. Buyers won’t simply look at your last month’s performance but will more likely examine the trailing twelve months (TTM) of EBIDTA – and some will also include prior year ends, as well. If the EBITDA for the most recent period examined is lower than earlier ones, expect the lower figure to be used. And if the most recent EBIDTA is higher, don’t be surprised if the buyer wants to discount it by averaging it with the previous lower periods.
Once your EBIDTA has been determined, you’ll need to figure out what multiple the buyer is willing to pay. In this industry in today’s marketplace, valuations of 4 – 6X are not uncommon.
| Multiple | Rate of Return to Purchaser |
|---|---|
| 4X | 25% |
| 5X | 20% |
| 6X | 16.7% |
Any number of factors both internal and external may influence the multiple a company is willing and able to pay. Internal factors include the company’s financial position, results of operations, competition and management, to name a few. External factors include things like the availability of credit, the cost of capital for the buyer, the status of the industry and the position of the company relative to the industry.
And that’s just the beginning of what influenced how much cash the seller will actually receive. Other factors include:
Debt – Buyers generally require assets to be free and clear; if you owe large sums, expect that debt to come right out of the proceeds of the sale
Working Capital – Think of this as your current assets minus your current liabilities. A profitable business without many owner distributions may be sitting on excess cash and receivables that should be factored into the overall purchase price.
Taxes – When you sell your business, you may be escaping the day-to-day grind, but you’re not going to escape the tax man. Expect to pay a 20% Federal capital gains tax, and don’t be surprised if your state has a tax ready for you, too.
One other less tangible factor in determining just how much you get for your business is the acumen of those who represent you. Many of the terms of the deal are negotiated, and having skilled representation can help ensure that you maximize your company’s valuation. Reaching a favorable close can be a tricky and complex process, and you’ll want as much expertise on your side as you can get.
- Steps To Take Today To Sell Your Business Tomorrow - October 16, 2018
- A Working Definition of Working Capital is Imperative! - February 18, 2016
- The Top 5 Mistakes HVAC Owners Make When Selling Their Companies - March 31, 2015
Posted In: Management, Money
