Business Valuation: What's Your Company Worth?
Business valuation is the formal process that establishes the true value of a business operation. Most jan/san distributors will tell you they already have an idea of what their company is worth. There’s only one problem: that idea is always wrong. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a common benchmark for measuring financial performance and cash-flow value. Many jan/san distributors apply EBITDA principles because they eliminate the effects of financing and accounting decisions.This process ignores any debt interest that a company might have accrued or expenditures on equipment, but it focuses on the health of the company’s sales. Although EBITDA does not actually measure cash earnings, it is a good measure for evaluating profitability.
Yes, says Brad Davidson, president of Securities Pricing And Research (commonly known as STARDATA), a national valuation consultant in Annapolis, Md., and a regular contributor to The Wall Street Journal, The Baltimore Business Journal and other business publications.
“My company has valued more than 27,000 businesses, and I have yet to meet an owner who didn’t have some number in his or her head about what his or her company was worth,” he says. “That number is always wrong, and it’s usually wrong by about 50 percent.”
Davidson offers the simple — but not uncommon, he says — example of a business owner who thinks his company is worth $1 million. “The owner may be overvaluing his company, in which case it’s really worth $500,000. Or, he could be undervaluing it, in which case it’s really worth $1.5 million. Either way, he’s wrong by a wide margin, and it’s going to wreak havoc on his plans for the future of his company. It will probably wreak havoc on his personal plans for the future as well.”
How can valuation prevent future problems for a business? Although business valuation is primarily used to determine a company’s value if it’s going to be sold, Davidson sees it as a useful tool for monitoring and assessing various assets that contribute to a company’s total worth. “I always tell business owners, ‘It’s imperative for you to know what your business is worth.’ A business owner’s company is usually his most valuable asset — more valuable than his house, stock holdings or other investments,” he says. “If you don’t know how much your business is worth, then you have great uncertainty about your financial future. You’re leaving situations like your retirement, the estate tax, succession planning and a potential sale all to mere assumptions.”
Business owners tend to focus so much of their energy on portraying their company in a positive light, that they aren’t objective about its performance history, says Don Kellermeyer, president of Kellermeyer Co., Toledo, Ohio. A potential acquirer will pay more attention to how a company is trending regarding future sales and profits.
“Distributors need to stop thinking about what their company has done in the past, and evaluate how it will do in the future,” says Kellermeyer, who has made several acquisitions and gone through numerous valuation processes in the past two years. “It may be a hard fact, but that’s all a potential buyer cares about. If you’ve been making $3 million every year, but all your accounts are beginning to decline, and your entire sales staff is retiring, then your company probably isn’t going to sell for what other $3 million-per-year companies might sell for.”
For Sale — At Some Point
The recent economic recession created a business climate full of uncertainties. Many of those uncertainties — fluctuating margins, shrinking customer budgets, inconsistent product quality from manufacturers — still exist, and they extend beyond the reach of a business owner’s control. Business valuation, however, allows owners to accurately determine how they can increase the value of their company and better manage the circumstances within their control. They’re better prepared to sell when the time comes, and they’re more likely to be adequately compensated.
“I believe that valuation is something that distributors should do on a regular basis because there’s such an awareness of it with all the current mergers and acquisitions,” says David Ellis, president of Lansing Supply, Lansing, Mich. “We usually don’t know what the future holds,” he says. “A situation could come up where an owner is suddenly forced to sell his business. There might not be a succession plan in place, and debts will have to be paid off eventually. It’s just a smart thing to do so that you can prepare for the future with discernment.”
Owners should never wait until they are in a situation where they are forced to do a company-wide valuation, says Charles Wax, president of Waxie Sanitary Supply, San Diego. Wax is a proponent of regular valuations for his company’s 14 locations throughout the western United States.
“There’s a big difference in working through the valuation process with a company that has been preparing for the possibility of a sale, and one that hasn’t,” says Wax. “The latter situation is often quite difficult, because it usually takes a while for the owner to get over the initial shock and emotionally prepare for what his company is really worth.”
The difference between the way that a seller values his or her business and the actual market value often is significant, says Tim Feeheley, president of JanPak, a jan/san distributor in Davidson, N.C. “We’re still a very fragmented industry, and you have a lot of multi-generational businesses that have just never gone through the valuation process,” he says. “Don’t get me wrong — they have great reputations and they’re great companies — but the first time you tell them how much their company is valued at, their jaw hits the floor.”
Ignorance is Costly
Most business owners don’t want to think about the possibility of selling their company, so they avoid doing a critical valuation. Unfortunately, unforeseen circumstances often dictate when a sale becomes necessary, says STARDATA’s Davidson.
“It’s sad, but it’s not all that uncommon for a business owner to have no intention of selling, but to suddenly die from an illness or an accident. Maybe an owner figured that his business was worth about $1 million, but it’s really worth $3 million. Typically, the owner has made some arrangements for who should get what percentage of the business. However, when the state comes in and does a valuation, it can seize 50 percent of the company’s worth because of the estate tax. In that situation, the only way for the owner’s family to pay $1.5 million (and they have to do it within 9 months) is to sell the company.”
Davidson argues that a proper business valuation can prevent many of the problems associated with the untimely death of a company owner. “The estate tax doesn’t look like it’s going away, and I’ve seen many companies get sold for 20 cents on the dollar by the state, because a proper valuation had never been done to see what a fair price was.”
Don’t Stop Finding Value
Valuation data allows business owners to strategize effectively, create incentives for accurately meeting company productivity goals, and sell the company for a fair price when that day comes. Ongoing valuations are important as the company changes, says Davidson.
“Once an owner has had his company valued, then I usually recommend that he get it revalued if the sales have grown or fallen by more than 30 percent,” he says. “If you’ve had a big delta in your revenue, then there is a corresponding increase or decrease in the value of the business.”
Wax agrees that valuation should be an ongoing process. “It’s wise to do it on a regular basis so that you can know where your company needs to improve,” he says. “A business owner needs to determine where the strengths and weaknesses are within a company, and valuation is a great way to do it.”
A recurring valuation process might uncover damage to warehousing facilities or that those operations are not running smoothly, for example. The cost of making improvements to the warehouses can be weighed against the impact those repairs have on the company’s total value.
While some distributors feel that annual valuations make the most sense, others say that the frequency needs to be less often in order to properly evaluate economic cycles. “Every 24 to 36 months is good,” says Feeheley. “I think going through the valuation process every year is a little short-sighted. You need some time to go through the business cycle, and you don’t want to base everything on the short-term market trends.”
The variables that influence valuation change over the years. A regular valuation process allows the business owner to take into account current economic models. “Valuation today is much more difficult than 25 years ago because there are so many different methods to pay for things,” says Wax. “The majority of companies are not paying with cash for their financing needs.”
During the course of valuation, a buyer tends to look at a number of variables — stocks, assets, branding rights and cash, for example — and often places a special emphasis on one or more. Some of the valuations conducted by Waxie focused on valuing the power of a particular brand in a particular region (and then purchasing that brand), while others focused on the pure cash-flow value of a company.
A Body of Worth
During the valuation process, many distributors realize that their customer base is a larger consideration for a potential buyer than facilities or delivery trucks, says Kellermeyer: “One of the first things to do is to figure the value of your customer lists. You have to ask a lot of hard questions regarding the health of those [sales] accounts. Are they growing customers? Are they in decline?”
Sometimes, the makeup of your customer base can work against you. Case in point: Kellermeyer Co. was extremely close to purchasing a company in Michigan, but negotiations fell through when the customer lists were examined. More than 40 percent of the seller’s business was attributed to one customer. If that customer were to move its business after the acquisition, the company would take a major hit.
A company’s sales staff also figures prominently into the valuation process. Usually, a veteran sales staff carries more value than an inexperienced one. However, if several salespeople are nearing retirement, that could make the sales force less attractive to potential buyers.
“So much of a company’s value really hinges on the salespeople,” says Kellermeyer. “If they have strong relationships with good customers, that’s very appealing to a potential buyer. That’s why buyers always try to figure out if the salespeople are willing to stay onboard.”
Not all distributors consider customers and salespeople when starting the valuation process for a business. “When we look at a business to buy, we usually look at the hard, tangible things first,” says Ellis. “We look at the inventory. Is there commonality with our inventory? We look at the real estate, the trucks, etc. Later, we move to the intangibles like customer base, the markets they’re in, the power of the brand name, and the potential of their geographic location.”
When a company is sold in an assets-only sale, it makes valuation somewhat easier, because the value of each asset can be determined individually and apart from cash flow. More common, however, is a purchase that involves the cash-flow potential of a business (see sidebar).
Use It, Or Lose It
Valuation often means little unless it is accompanied by follow-up measures, says Wax. “To me, when you figure out the value of the company, you need to also find out how you are going to run it and organize it,” he says. “How much a company is worth in dollars is only part of the equation. If you’re looking to buy a company, many times you have to invest heavily in order to run it the way you want. If you’re conducting an internal valuation, then you better have a plan in place to leverage the information that you’ve gained.”
Companies that are disorganized or performing well below their potential can be prime acquisition candidates, says Kellermeyer.
“That’s really an ideal acquisition for a buying company — when the business that’s being bought has underperformed due to mismanagement,” he says. “In that case, it’s not hard to come in, see why things haven’t been working, and correct the mistakes so that you’re profitable.”
“If you’re going to buy a company and just run it the same way it has always been run, then why did you buy it in the first place?” asks Wax. “The reason a company is sold is usually because it hasn’t been profitable.”
If most mergers and acquisitions occur because an outside company believes they can do a better job of running things, then business valuation is not only a precursor to those transactions, it’s also similar in its goal — to run a company more efficiently and profitably than it has ever been run before.
Sanitary Supply Sellers and Buyers Turn to EBITDA for Valuation
Potential buyers often use EBITDA as a benchmark in valuation. In the late 1990s, companies in the jan/san industry were being sold for high multiples of their EBITDA, says Tim Feeheley, president of JanPak, Davidson, N.C. “Between 1996 and 1999 the EBITDAs were extremely high,” he says. “People were paying 8, 9 or 10 times as much as a company was worth. For example, in 1997 a distributor’s EBITDA might have been $1 million, but they could sell [their company] for $9 million. It really got out of hand.”
During this time, the jan/san industry was really a “seller’s market,” so many buyers stopped making acquisitions, explains Don Kellermeyer, president of Kellermeyer Co., Toledo, Ohio.
When the economic recession hit in 2000, companies lost most of that inflated value. “It was really a triple-edged sword for those companies that went through the valuation process in order to sell,” says Feeheley. “First, the multiples went way down; then, their earnings were also going down; and finally, no one really wanted to make an acquisition because of their own financial problems.”
Currently, valuation indexes seem to be more realistically attached to a company’s revenue potential, says Kellermeyer. “People are no longer paying indiscriminate prices for companies,” he says. “Now the multiples are 2 or 2.5 more than the EBITDA. It’s pretty concrete — I think it will stay that way for a while.”
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a common benchmark for measuring financial performance and cash-flow value. Many jan/san distributors apply EBITDA principles because they eliminate the effects of financing and accounting decisions.This process ignores any debt interest that a company might have accrued or expenditures on equipment, but it focuses on the health of the company’s sales. Although EBITDA does not actually measure cash earnings, it is a good measure for evaluating profitability.
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