Who Determines What Your Business is Worth?

Who Determines What Your Business is Worth?

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You may be thinking it’s time to sell your IT services business. To do that, you need to know what it’s really worth.

Most business owners will tell you they have a number in mind. Often, the number comes from a friend who just sold, or a valuation approach touted in an article. Rarely, however, is the number linked to a hard evaluation of the business’ assets, liabilities and profit generation capabilities when in the hands of a buyer. If you put all the pundits in their place, which is off to the side, you will quickly discover the buyer determines the price – not the seller.

If you’re surprised to hear that, you haven’t been paying attention to what’s been happening in the marketplace. Let’s take the art world, for example. A painting by Winston Churchill, which was acquired for $2.95 million a decade ago, recently sold at auction for $11.5 million. Consider that the pre-auction estimate for the painting ranged from just over $2 million to $3.4 million based on previous sales of similar paintings by Churchill. The buyer obviously saw value in the painting and was willing to pay a super-premium to own it.

While it’s not likely that your IT services business will hit the auction block and garner a premium, this example illustrates the buyer’s ultimate power. It’s been said, and it certainly rings true, that a company is only worth what a buyer is willing to pay for it.

Consider the traditional way of figuring out what your business will bring. If you start your price determination process as most business owners do, you might base your company’s value on a discounted cash flow analysis or a revenue/earnings multiplier.

Each of these approaches offers a starting point, yet each fails to deliver what we at Cogent Growth Partners call a “Market Value Analysis” (MVA). The process of analyzing a business to set a purchase price range and deal structure that a likely buyer would consider is what creates an MVA. That selling proposition uses a clear understanding of the industry and market to take into account how the likely buyer will operate and profit from the business post-sale. The MVA bridges the missing links between a valuation and purchase price, incorporating the impact of M&A reality, industry knowledge, and a view of the business through the lens of likely buyers.

The MVA, which evaluates the financial impact of post-transaction consolidation, synergy and growth potential to quantify and qualify the free cash flow (FCF) available to the company’s new owner, includes seven key components:

  1. Buyer/seller size and maturity
  2. Buyer’s purpose and seller’s need for the transaction (the opportunity)
  3. The operational and cultural match of the buyer and seller (the fit)
  4. The seller’s risk profile and the buyer’s tolerance for risk
  5. A reasonable Opportunity-Delta™ showing the potential forward FCF for the buyer
  6. The deal structure
  7. The buyer’s return/investment horizon

Factors that do not contribute to the potential purchase price, and in some cases drag it down, include the company’s years of operation, owner’s sweat equity, over- or under-staffing, the company’s previous higher revenues and/or profitability, and the unreasonable expectation of a seller to take a majority of the gains from the buyer’s future investments and efforts that the seller could never realize. These irrelevant considerations have depressed purchase prices, extended closings and, in some cases, completely derailed transactions.

Savvy sellers consider their value as a buyer would. They honestly determine how much future profit a buyer could achieve with the least amount of effort and risk in a reasonable period of time. The more substantial and risk free that potential of future profit, the more favorably the deal will be structured and the higher the sale price will be.

Finally, the most useful MVAs take into account the current owner(s) exit plan and answer three key questions:

  1. Does the transaction involve a party internal to the company or an outside entity?
  2. If the potential buyer is an outside party, is this transaction an add-in to an existing business or a platform play?
  3. Is the seller(s) planning to stay or leave post-close?

Additionally, an MVA that is done for future planning should analyze the current state of the business to help the buyer maximize return and reach selling goals over time.

Whether you are selling your company today or a decade from now, understand that it is how a buyer sees your business that ultimately determines how much you gain and when you gain it. The value of your IT business and a Churchill painting may be more alike than you previously thought.

About Cogent Growth Partners

Cogent Growth Partners, LLC, a buy-side intermediary for mergers and acquisitions, taps into the growth opportunities found in America’s IT services businesses. Cogent accelerates the M&A process with a set of proprietary tools and processes that enable buyers and sellers to stay focused on running their respective businesses. Anyone who wants to know why Cogent is different, need look no further than our business card: “Providing Transaction Therapy™ for IT Business Owners Since 2010.” For more information, visit www.cogentmergers.com or call 678-820-5290.