When you sell your business, you will talk to friends and mentors and ask for their opinions. You’ll want to know if they agree with your decisions. You’ll probably ask, “What do you think is my business worth?” In a previous blog we saw that valuations are based on measurable financial data, and adjusted through a “multiplier” (that varies by industry). That, plus the value of your assets… if any… provides a pretty straightforward valuation. Alternatively, you can find firms that are similar to your that were recently sold. But, when you look closer apparently similar firms sold for different prices. How can this happen? Aren’t valuations “scientific”, aren’t three formulas that are used to determine value? As you will see, there are formulas, but there is more to valuation than just financial data!
A good valuation combines art and science. We see this in large, global corporations. Firms with different fiscal years, using different national tax systems, dealing with different local issues, and using multiple currencies, somehow provide comparable information every year.
That doesn’t mean that they don’t have issues to overcome. Let’s say the UK office, which may be barely profitable, might appear to be doing very well just because the Euro went up. Or the reverse might happen when the Euro falls, deflating the UK contribution. Determining “real” value in a global firm requires complicated analysis. Still, the formulas for valuation exist, and the bigger the firm the more financial data is available. Valuation, while complex, should at least be reliable. Right?
Let’s test that theory by looking at the market value (capitalization) of a publicly traded firm. The market capitalization is simply the number of shares of stock multiplied by the price of a share of stock… all public information. A firm with 1,000,000 shares of stock that sells for $10 a share is valued at $10,000,000. Simple!
How can anyone disagree with this? It so happens that most of Wall Street spends every day telling us that this valuation is wrong. Wall Street employs tens of thousands of financial analysts. Each analyst examines the same public information, but they often come to very different conclusions.
Could it be that some analysts have access to better information? After an analyst covers a firm for years, they probably develop relationships with that firm. They might have access to information on products before they are released, plans to make an executive hire, upcoming major lawsuits or other inside information that might change the value of a firm. That information could be incredibly valuable, but it would also be completely illegal.
Receiving or acting upon any information that has not been officially made public (also called “material non-public information”) is the definition of “Insider Trading”, a Federal offense. Government regulations make it very clear that publicly traded firms cannot provide inside information and financial firms cannot receive that information or take any actions based on it. It’s a level playing field, where everyone has the same information.
If everyone has the same information, analysts should have come to very similar… if not identical… valuations. One sign of how financial analysts value a firm is in their “Buy, Sell, Hold” recommendations. “Hold” means the market price is correct, “buy” means it’s too low and sell means the price is too high. Most analysts use a 5 tier system that goes something like: Strong Buy, Buy, Hold, Under Performing and Sell.
This may not show what an analyst thinks a firm is worth (that’s reported through other metrics), but shows if they agree that the firm is worth what the public is paying. Again, analysts all use the same publicly reported data, read the same market reports, follow the same rules of accounting, were trained using the same Corporate Finance textbook, and use virtually identical spreadsheet models.
I randomly picked IBM for our example. This is a very well known, very well researched, publicly traded firm. The market capitalization (price) changes every day, but as of today, it is $135 billion. In the graph below we have recommendations from 16 analysts. Only half say that the price for IBM stock is correct (hold), the other half think the price is wrong (buy or sell).
Do Professional Analysts Agree?
Do the dissenters at least agree as a group that IBM is EITHER that it is over or under priced? Not at all! Six think the stock is under-priced and two think that the stock is overpriced. And everyone used the same information to develop their opinions. More complex mathematical question… how far away is the moon, what is the weight of Mount Everest, how many bricks are in the Great Wall of China… are answered with far greater consensus by experts in these field.
Ultimately, the “right price” for a business, is subjective. Two buyers may agree exactly on the price of a firm, today, but disagree how a change in the economy will impact the value tomorrow. In a previous article, we spoke about the “multiplier” that is used to determine value. The multiplier changes, depending on the industry.
Consider a staffing firm that staffs programmers. Your list of customers might be largely the same as one buyer, but may have open up many new accounts for another buyer. You might only have a single customer, which is usually a very big negative, but a buyer may want you specifically to get this one account. Likewise, IF software companies are valued at a higher multiple than consulting firms, an IT consulting firm that completely manages their own staff might be valued more like a software firm than a consulting firm. Especially if the buyer is a large software firm.
Unlike textbooks, the real world has exceptions and special cases. Valuation formulas provide a baseline, but the buyer is a very big part of the final offer. Your value is different for every Buyer you meet. In order to get the maximum value for your firm, you not only need to understand your firm, you need to understand the buyer’s firm and their motivation for buying.
When two firms have a good “fit” their combined value is the highest. Usually, not always but usually, buyers are aware of the fit. The buyer provides the seller financial and other information, so the buyer has an opportunity to understand the details of your business. However, the seller usually provides far less information. After all, you’re not paying the seller.
There’s no magic fix that will tell you how you will fit with another company. You just need to do the basics:
- Do some research. Has the buyer been in the news? Have they said anything about their plans?
- Look at the buyers website, the Linked-In profiles of the individuals you are negotiating with, and
- Have dinner with the buyers team. Not just the ones working on buying your firm, but operations and sales. Talk to them about what they need to accomplish and how you fit in.
- Speak to the buyers customers. They may be listed on their website, personal contacts may help or the buyer may direct you to customers who would be comfortable talking to you.
If you want the best price for your firm, you need to find the firm that fits best. And you need to know how to tell the tale of how your two firms are worth more together than apart. If you can’t identify and articulate this fit, you may get a good deal for your firm, but you may not get the best price. At least that’s my Niccolls worth for today. Next? We’ll take a look at firms with a special “something” and what it’s worth!
Niccolls AND Dimes 