Inventory and Valuation

August 14th, 2012

When doing a valuation, the value of inventory is adjusted from book to fair market value. However, sometimes that is not sufficient to make the valuation accurately the value of the business. You may also need to adjust the income statements that are used in the valuation. Here’s why:

Inventory can be valued on the balance sheet using a variety of methods. You can, for example choose to assume that the inventory purchased most recently is sold first (FIFO First In First Out) or that the oldest inventory is sold first (LIFO), or use Average cost, or even specifically track each individual item (usually with high value items such as cars). Often, the inventory accounting method is chosen to minimize profits for tax purposes, but using profits calculated in that way may lead to an underestimate of the value of the business.

New calculator

March 18th, 2012

We have created a new calculator that allows a business owner to evaluate the cost effectiveness of daily deal advertising from companies like Groupon, Living Social, or Google Offers.

Our Book: Strategic Acquisitions: A Smarter Way to Grow a Small or Medium Size Company

February 28th, 2012

We are pleased to announce that Strategic Acquisitions: A Smarter Way to Grow a Small or Medium Size Company originally published in November of 2009 is now available in Kindle format. Additional information and excerpts from the book are available at

Customer Concentration

August 19th, 2011

Pretend there are two companies with identical financial statements. We’ll call them Company A and Company B. Both have been in business the same amount of time, and they are both in the same industry. They are even located in the same city. Yet one will likely sell for at least 20% more than the other.

Why is this? Company A has 15% of its business with a single customer and 10% with another single customer. Company B has no single customer that accounts for more than 3% of total business. No matter how wonderful those two big customers of Company A may be, that level of customer concentration negatively impacts the value of the company.

Buyers are very skittish about buying a business with significant customer concentration issues. They won’t be convinced by assurances that the large customers(s) will not go elsewhere. The fear: if I lose a customer that accounts for 15% or even 10% of total business, the business I just bought will suffer significantly. It could even put my business in sever danger. Even if they retain those large customers, the reality is those customers have a great deal of power over Company A. Suppose the 15% customer decides to pay in 60 days instead of 30. What does the new owner do about it?

Buyers will, with some justification, discount the worth of very large customers when computing their view of business value.

S&P Downgrades US Debt, How does this impact the value fo my business?

August 8th, 2011

Well, since US debt has never been downgraded before, we don’t know. However, it’s very possible that it will make credit more expensive and harder to come by. Since most business acquisitions involve, some amount of borrowing, it may negatively impact the value and salability of your company.

On the bright side: more people are looking for investment alternatives. Stocks, bonds, and cash are all doing poorly now. Some people will reason it’s better to invest in buying a going business than in more traditional investments.

Business Valuation Multiples

April 6th, 2011

Many, if not most, business valuation methods rely to a degree on multiples of earnings.  That is, annual earnings of the business being valued, are multiplied by a number to arrive at its estimated value.  What’s the number?  Well, arriving at the multiple for a particular business involves a mix of experience, data, and art.  Factors such as size, competition, longevity, industry, and even location impact on the multiple for which a business will sell.

Stock in venerable public companies often sell for Price Earnings rations (essentially multiples) of 15-18.  Stock in fast growing companies public companies sell for even higher multiples.

Sometimes owners of privately held small companies reason that their company will sell for multiples in those ranges.  However, they’re disappointed learn that is not the case.  Small privately held companies tend to sell for multiples ranging from about 2.5 to as much as 6.  There certainly are exceptions, but this is the typical range.  You see, small companies are inherently risky and buyers (investors) demand a premium for that risk.  What’s more, you can buy pretty much an amount of stock you want in a publicly traded company, and sell all or some of that stock at any time you wish.  In buying a privately held company you don’t have that kind of flexibility or liquidity and investors demand a premium for that liquidity as well.

Rules of Thumb Valuation Methods

March 23rd, 2011

Many people are convinced that there are some quick rules of thumb that could determine the value of a business. Some of these rules of thumb state, for example, that an insurance agency is worth 1.5 times annual commissions, or that a chemical manufacturing company is worth 6 times its EBIT. These formulas may indeed be fair averages, but they give very little help in determining the value of a particular business.

The problem with rule of thumb formulas is that they are statistically derived from the sale of many businesses of each type. That is, an organization might compile statistics on perhaps 50 chemical manufacturers that were sold over a three-year period. They will then average all the selling prices and calculate that the average chemical company sold for an amount equivalent 6 times EBIT. The rule of thumb is thus created. However, some of those companies may have sold for 2 times EBIT, while other for 7 or 8 times EBIT.

The business with expenses and profits that are right on target with industry averages may well sell for a price in line with the rule of thumb formula. Others will vary.

Rule of thumb approaches tend to work in two situations: One is in industries that are rapidly undergoing consolidation, especially if the rolled up companies are being taken public.  In the late 1990s and early 2000’s, for example, internet service providers (ISPs) were bought and sold based on number of subscribers or subscriber revenues.  The other situation in which rules of thumb work well is in acquisitions where the cost structure of the acquired company is almost irrelevant to the acquirer. An example is the payroll industry. When a large payroll processor acquires a small operation, the percentage of revenues spent on labor, software, rent, etc. becomes irrelevant as the customers are switched to the larger processors software and systems.

“Gray Area” Business Sellers

March 22nd, 2011

At any given time, a few businesses are actively on the market.  While you might find a few good acquisition candidates from the pool of businesses that are listed for sale, the odds of doing so are not great.  What’s more, once a desirable business is actively advertised for sale, it will attract several qualified buyers leading to significant competition among the suitors.

There are a lot of business owners that aren’t actively looking to sell but would consider selling under the right circumstances. We call these the gray area sellers. It is among these gray area sellers where we believe the best strategic acquisition opportunities lie.

Finding these gray area sellers is not easy.  Selling one’s business is an emotionally wrenching undertaking, such that even an owner considering selling will not always readily respond to a query about selling.

In future posts, I’ll outline some methods for finding gray area sellers.

Are You in the Ballpark?

March 21st, 2011

Often, too often, a would-be buyers and would-be seller spend time in phone conversations, meetings, and information gathering, only to realize they are very far apart on valuation and terms.  It’s good to establish ASAP whether you are in “deal making range”.  We like buyers to submit an initial non-binding  proposal that sketches out price and terms.  This proposal can and should be market as “for discussion purposes only” and “not an offer”.  It’s fine if details are missing at this early phase.  The purpose is to discover whether a deal is within the realm of possibility.  If  buyer & seller are say  10% or 20% apart, a deal could well happen.  If however, the parties are say 50% apart on price and seller wants all cash and buyer expects  that seller to finance 70% of the deal, well there probably will be no deal and therefor no reason to spend more time trying to make one.

Is this the Right Time to Sell My Business?

March 21st, 2011

Much is made of this being the right time or the wrong time to sell one’s busienss based on the economy, the political climate, or other outside factors.  IMO, the right time to sell is when you decide you’d be happier doing something other than running your business every day.  I’ve seen it all too often: an entrepreneur builds a business and eventually looses enthusiasm for it, until it becomes more burdensome than fun.  If he holds on to the business beyond that point, it slowly but invariably deteriorates, ultimately to to the point where it is no longer a salable asset.

Having said that, the economy for M&A has improved lately.  Some lender money is flowing and prospective buyers are, well, becoming real buyers.

In summary: if you are ready to sell, don’t let the economy or the M&A climate hold you back.  You can no more time the best moment to sell your company than you can time the stock market.