Archive for February, 2008

New Book and WebSite

Thursday, February 21st, 2008

I was working on doing another post about comparables, but something got in the way…

Gary Schine and I have Written a new book “Guide to Selling a Business” and created a website, based on the book. The website can be found at The book and site are meant to be a complete guide to selling a small to mid-sized company, whether you choose to do it yourself, or hire an intermediary. As always, any feedback is welcome.

The problems with using comparables as a valuation methodology

Saturday, February 9th, 2008

One method of valuing a business is to use comparables. In the world of small businesses, this is often a mistake. Let’s look at some of the reasons why.

I ran a report from a prominent data provider (who now offers free valuations based solely on these comparables) at the request of a buyer who was purchasing non-emergency medical transportation companies. Let’s look at some of the issues with the report. To begin with, although the data provider was a reasonably large player and the database contains about 17,000 transactions no category narrow enough to match what my buyer was interested in, so we ended up using a category titled “Services – Local Passenger Transportation.” We got a result based on 34 sales over a 5 year period, a period that included wide fluctuations not just in the market for small businesses but also in things like the price of gasoline that had disproportionate impact on this industry.

The average Cash Flow Multiplier was about 2.4, the median was 1.9. So, could my client conclude that a seller who was asking 1.5 times EBITDA was a bargain and one who was asking for 3 times EBITDA was asking top dollar? Not really. If we look at the descriptions and limit ourselves to transactions that had occurred within the last year, we find only 2 transactions are left, not enough to base any real conclusions on. Their multiples of cash flow were 2.47X and 3.64X.

What is more important than what we know about these companies is what we don’t know. In this report we have no idea how strong the balance sheets of each company was and medical transportation is a capital intensive business. Even if we had the balance sheet, there are many things that can affect the numbers on that balance sheet making two balance sheets hard to compare without an in depth analysis. For example, choosing a different method of depreciation can materially affect the value of the balance sheet.

There are also things that are never reflected on a financial statement. A business in a rural area will sell for less then one near a major city. A business that is growing is more attractive than one that is not. Unless you know a lot about the businesses being compared you can’t decide how relevant the information is.

Most business comparable reports don’t contain enough data to allow a reasonable assessment of true value. It’s like trying to assign a value to a house based only on the square footage, the number of bedrooms, the number of bathrooms, and the fact that it is in Los Angeles. To get real value you would need to know what shape the house was in, what neighborhood, etc. Anybody who tries to value a home on the basis of broad averages would be laughed at. Unfortunately, businesses that are even harder to value fairly based on comparables are often valued in just that way.

In the next post I’ll talk more about the problems with using comparables to value a small to mid-size business and the one after that I’ll talk about where they can be useful.

When is the right time to sell?

Tuesday, February 5th, 2008

The short answer is never, unless it makes sense from a personal point of view.

There are brokerage firms that call people when business is booming and the economy is humming along and tell prospective sellers that now is the time to sell, while prices are high and business is good. You’ll get a higher multiple, they claim, and there is an element of truth to that. However, as we know the market environment can change in days or weeks and selling a business takes months or years. How do you know that your business will sell before the market turns down? Conversely, the good times may last years. If you are growing at 25% a year and sell today, who’s to say that you wouldn’t have been better off waiting three years and selling for double (25% compounded over three years is 95%).

When business is bad, companies consolidate and the same brokers who argued that you should sell during the good times now point to the industry consolidation and use that as a reason that now is the time to sell. They say that you should sell before the economy gets worse, before too many competitors merge and leave you as a smaller player.

Here’s a dose of the truth. It almost never makes sense to sell a healthy business based on a strictly financial analysis. If I can get you 3 times earnings today you’re better off waiting 3 years then selling (even if you can only sell for a penny). If I can get you 5 times earnings you’re better off waiting 5 years, 7 times earnings; wait 7 years and so on.

Yes, there are advantages to selling now. Selling frees up your time which is worth something. Selling allows you to diversify your financial holdings and reduce risk. However, the time to sell is when you begin to feel burned out, you’d like to travel, or spend more time with your family. In short, sell when it makes sense for personal reasons. Sell when selling makes you happy.

Bottom line: don’t try to time a process that takes months or years to hit a particular day or week. Maximizing the multiple is nice, but unless you know how long a transaction will take, what will happen with your particular business, what each prospective buyer’s finances will be like in the future, and when markets will peak with some degree of certainty, it’s not an achievable goal. If you can accurately predict markets performance months in advance play the stock market and get rich.