Selling Companies

Valuation

Expected selling price is probably the most important issue to everyone selling a business. This is true whether the seller is an entrepreneur approaching retirement and seeking to move his or her wealth into liquid form; a corporation intent on refining its core focus by divesting a non-core subsidiary; or an investment fund considering selling a mature business investment in order to realize and distribute gains or to reinvest in timely new opportunities.

The value of most successful businesses varies significantly among potential purchasers. Value can also fluctuate widely depending on external factors such as economic, capital market and credit conditions, as well as the industry outlook and business confidence. The ultimate selling price will also be affected by the sale process itself.  For example, fiercely competing strategic buyers may, in the heat of the battle, bid premiums to accelerate their own corporate growth agenda and prevent competitors from doing so.

While these and other variables render valuation much more art than science, a reliable baseline valuation, as an indication of expected price, is an important starting point for the sale process.

Valuation Approaches

Purchasers use many valuation techniques in developing their bids.  The most popular approaches include: multiple of adjusted earnings or free cash flow; multiple of revenue; discounted cash flow; and variations of each of these.  Additional adjustments are typically made for redundant assets and excess or deficient working capital.

In our experience over the years, the most common primary valuation approach, and the preferred bid basis, used by purchasers of private companies is Total Enterprise Value (TEV) determined by applying a multiple to sustainable EBITDA (earnings before interest, tax, depreciation and amortization). TEV is the aggregate value of the company’s shares and term debt, i.e. the value of the shares is the agreed TEV less the amount of term debt at closing.

Sustainable Earnings

Historical operating results, usually over the past three fiscal years, together with forecast results for the current fiscal year are the starting point for most purchasers in assessing sustainable EBITDA. Adjustments will often be needed for large income or expense items of a non-recurring nature, such as foreign currency gains or losses resulting from a past foreign exchange situation, unusually large bad debt write-offs, gains and losses on asset sales or sales of discontinued business operations, etc.

Where the recent earnings history exhibits large year-to-year fluctuations, rather than a pattern of continuous growth, the challenge is to identify, eventually in a way that is convincing to purchasers, the non-recurring negative factors and adjust for these in the sustainable earnings calculation.
In those private companies where most or all of the shares are held by active managers, it was very common until recently for substantial performance bonuses to be paid to shareholder managers out of annual earnings, and having the after-tax proceeds lent back to the company, rather than leaving these earnings to be taxed in the company at full corporate rates.  While this practice is no longer the norm, historical earnings typically need to be adjusted to reflect the market bonuses that would have applied in normal circumstances.

Similarly, closely-held private companies often incur, at the behest of the shareholders, costs that are not likely to be incurred under new ownership.  Some examples include unusually generous contributions to local charities, university endowment funds, etc. and gratuitous enhancements to pensions of already retired workers. Sustainable earnings should be adjusted to reflect only the costs that are likely to be incurred under new ownership and control.
In a well-managed sale process the Information Memorandum and supporting due diligence material will convey a powerful and convincing message to purchasers as to the sustainable earnings of the enterprise. In the process of estimating selling price, a diligent effort to identify and evaluate all sustainable earnings adjustments will produce a more reliable valuation result and better control over the sale process.

Market Multiple

Purchasers look mainly to recent completed acquisition transactions, and to the trading multiples of comparable publicly traded companies in developing an EBITDA multiple for their bid strategy. In general, comparability involves not only the industry sector, but also factors such as the earnings and revenue growth rates of the company itself and the comparable companies.

In the case of private companies, the use of comparable multiples is inherently imperfect, as the transaction data are incomplete and the comparability is difficult to determine. Both the transaction data and the trading data may require adjustment; most of the transaction data will typically include larger companies and thus require adjustment for size factors, and the public trading multiples should be discounted to reflect generally lower valuations of illiquid private company shares.

Redundant Assets

Where the company owns assets that are either redundant to its business operations, such as real estate leased to others and not needed for expansion, or that could much more efficiently be leased than owned relative to the company’s cost of capital (offices in highly attractive locations, some types of transportation and production equipment) these should be valued incrementally at their net sale value.  Sustainable earnings should be adjusted accordingly.

Working Capital Adjustment

It is implicitly assumed in the TEV valuation approach that, at closing, the company will have working capital reasonably sufficient to continue operating the business at its current and forecast scale over the next year or two.  In closely-held companies this is often not the case; for example, working capital may be unusually low where short-term bank borrowings have been used to finance capital expenditures, even temporarily, or working capital may far exceed operating needs where the shareholders are leaving funds in the company and reinvesting them through the company rather than paying dividends and investing at the shareholder level.

Purchase price adjustments for excess or deficient working capital are virtually universal in private company sale transactions, and are probably the most common source of contention, sometimes causing derailment where these adjustments are not dealt with early in negotiations or are not anticipated by one of the parties.  In estimating selling price, and preparing for the sale process, it is important to anticipate this important component of negotiations by internally conducting a diligent analysis of actual working capital requirements based on at least two years of monthly data and two years of forecast operating levels.

Special Valuation Factors

Unique characteristics of your business can significantly influence purchaser interest and value. For example, the ownership of attractive and well protected intellectual property, not yet fully commercialized but clearly capable of larger scale can be a major positive to value and to a highly competitive sale process. On the opposite side, concentration of sales to a single customer or very small number of customers will add to a purchaser’s perception of risk and generally depress values and/or result in some of the purchase price becoming dependent on future results.

Our Role

Cambridge will manage every aspect of the sales process, which usually consists of the following main steps.

Throughout the entire process, we will communicate with you clearly and frequently on progress, potential concerns, upcoming decisions, etc. Issues may arise at any stage that will require additional time and attention to ensure full value is achieved.

• Pre-sale Planning

  In preparing the business for due diligence and for sale we will help you identify and resolve potential issues that may arise during the process or may be dealt with now to enhance value. Some examples include environmental issues, intellectual property deficiencies, litigation and disputes, sale of peripheral assets, renewal or extension of valuable contracts, sale or closure of non-core business units, and back-office housekeeping. 

• Prepare Confidential Information Memorandum

  We will prepare the Confidential Information Memorandum, which is the main marketing document setting out key information on the business.

• Identify potential purchasers

  We will identify an initial target list of potential acquirers. We will assess which strategic buyers are likely to be particularly motivated to buy your company or prevent a competitor  from owning it.  We will assess the likely acquisition fit,  financial capacity and closing reputation of each potential strategic and financial buyer. The target list will be screened in consultation with you.

• Confidentiality and Disclosure

  We will make an initial approach to selected potential acquirers on a confidential basis without disclosing the name of your company. After a Confidentiality Agreement has been signed, the name of the company and the Confidential Information Memorandum be provided.

• Meetings with potential buyers

  We will help you prepare a brief presentation for prospective buyers.  We will arrange and attend meetings with potential acquirers and respond to questions they have about the company.

• Control negotiations

  We will apply our experience to establish and manage a timetable to control timing of buyers? offers, ensure that you can compare offers and let the buyers know that they are in a disciplined competitive process.

• Indicative Offers

  In addition to price, we will ask the purchaser to provide details of funding, timetable, due diligence requirements and plans for the business. We will assess and advise you on the effective value and risk of each offer and help you select a short list consisting of at least your preferred bidder and one or more standby purchasers to maintain competitive tension.

• Initial Due Diligence

  Short-listed buyers will be permitted to conduct preliminary due diligence in a process that we will carefully control to protect the company and its business.

• Final Offers & Negotiations

  We will meet with the short-listed purchasers, review their offers and due diligence findings, and negotiate stronger terms.  Buyers will often enhance their offers in order to stay in the running and in order to be selected as the preferred purchaser.

• Final Due Diligence & Negotiations

  The selected buyer will be given an exclusive opportunity for a very limited time to conclude its final due diligence and settle a definitive agreement for the transaction.  During this time, a standby buyer will be maintained in background reserve to strengthen your negotiating position and prevent the selected buyer from grinding the price or terms.

• Closing the deal

  To successfully close the deal we need to actively manage the process through to completion, working alongside you, the buyers and lawyers to resolve any agreed conditions and negotiate the inevitable late issues.