By Dave Driscoll
Closely held business value can be defined as what the business is worth to someone without the owner.
There is so much going on in that seemingly simple statement that it’s hard to decide where to begin. Let’s break down the sentence…
A “closely held business” is a business whose shares are held by only one or a small number of stockholders. The stockholders typically have a common interest in the company (i.e., family members), and the shares of stock are generally not traded in the public stock market.
Value is an opinion based on a professional’s perception at a point in time given the market. It is not a hard fact. Value, aka selling price, must then be mutually agreed upon by both seller and buyer.
Fair market value or “what a business is worth” then is the amount at which a business would change hands between a willing seller and a willing buyer when neither is acting under compulsion, and when both have reasonable knowledge of relevant facts.
And then the end of the sentence has the most significant impact… without the owner!
“Without the owner” drives and influences the meaning of the entire sentence. Here are two examples of owners of closely-held small businesses that may change your opinion and behavior in your own situation.
Owner A– The owner has worked hard to empower employees to take ownership of responsibilities and supports them making decisions. The company thoroughly trains employees for their positions and has manuals that define processes. The owner can take time off from the business without disruption (to the business or the vacation).
Owner B- The owner is in the center of all operations. Employees look to the owner for guidance and decisions on day-to-day issues due to a fear of suffering consequences if everything is not done the owner’s way. The owner seldom takes vacation and when he or she finally does, they call in multiple times per day to trouble shoot and control operations.
Both companies have similar cash flows and, from a pure cash flow multiple of like-kind sales, have equal values. But which business is likely to maintain its cash flow with a new owner?
Clearly, Owner A is much more likely to receive a fair value when they sell the business. Owner A may not only get the maximum price, but also better terms due to a buyer’s confidence their own ability to maintain the business’ cash flow.
Owner B is not likely to receive the expected market value when selling their business. Any company that is owner-dependent will have difficulty transferring the value via business cash flow under a new owner, presenting more risk to prospective buyers. If the business does attract a buyer’s attention, not only will the value (selling price) be less, but the terms will likely require the seller to share in the risk through earnouts contingent on future cash flow.
Most owners are relying on the sale of their business to fund a major portion of their retirement nest egg. How you manage your business on a daily basis has a real impact on achieving the retirement of your hopes and dreams.
Dave Driscoll is president of Metro Business Advisors, a mergers & acquisitions, valuation and exit/succession planning firm helping owners of companies with revenue up to $20 million sell their most valuable asset. Reach Dave at [email protected] or (314) 926-1091. www.MetroBusinessAdvisors.com