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Podcast (10k-podcast): Play in new window | Download (Duration: 42:21 — 29.5MB)
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We talk about the business valuation process with Terry Lammers. Who helps people buy and sell the business; values businesses and coaches in the programme.
Terry Lammers of Innovative Business Advisors
Terry helps people buy and sell the business; values businesses and coaches in the programme CEO to CEO “Chief Everything Officer to Chief Operating Officer”
Terry’s book:
“You don’t know what you don’t know”
Everything you need to know to buy or sell your business
Getting an accurate valuation of your company
What are the classic errors that people make?
People overvalue their business!
Terry has trademarked the “bankability method” – they usually value the business in the way a bank would:
Can you make a reasonable downpayment at the bank and buy the company within 3-5 years?
That’s the main deal for buyers.
What do we need to think about when selling?
The main part of the value comes from accurate financial statements.
This is something many business owners or managers struggle with, even those who run quite large businesses.
Normalising the statements
Terry has owners go through “Normalising” financial statements.
Which includes:
- Depreciation and Amortisation
- Seller discretionary earnings
- EBITDA
EBITDA is NOT pre-tax profit!
Your company is not about sales and net income, it’s about Gross margin and cashflow.
Depreciation
Depreciation is a non-cash expense you use to write down.
You can take a large chunk in one year “USA” eg buying a truck
Normalising owner’s salary
Sometimes the owner doesn’t pay themselves anything. If so, they need to add in money to account for this.
If there is an overpayment of salary eg $300K pa for a $1M a year revenue business, you add back in the difference. In this instance, you might add back $200,0000 to the net profit and take just ascribe $100,000 to the director’s salary.
When you have expenses like cellphone bills, you need to be able to invoice the company specifically for bills.
Saying that of $10K for phone expenses “about 3K is personal” is not going to be popular with any buyer of the business.
Determining fair Director’s salary
In the USA, the Bureau of Labor Statistics can give you a fair number.
If a company cashflows $100K a year, if a fair salary is $50K, it only gives the company a profit of $50K for example.
What do you do about any equipment?
Say a computer or a machine – you buy this to create cashflow.
If the value of the cash flow exceeds the value of the equipment, you have goodwill in the company.
Book value vs market value
Excavating companies have a lot of equipment.
The “Book value” of the computer does not represent the “market value” of the computer.
If you have a computer worth $1000 new, and after 4 years, the book value of it is $200, you can sell it at “book value” of $200. But that doesn’t tell you about the cash flows which that asset enables the company to generate.
Owner involvement in the valuation
Owner excessive involvement doesn’t do much affect the financial valuation of the company. But it may often push a company from sellable to unsellable.
Financial vs Strategic Valuation
Financial valuation
If $50K is the profit (Cashflow), $50K manager’s salary.
Start with $50K as the cashflow.
Then usually multiply 3-4X to get the business valuation.
Strategic Valuation
Terry sold his business for a large multiple because it was a valuable strategic purchase for the buyer to eliminate a strong competitor to the market and had a lot of assets.
Multiple
Company value is usually a multiple of EBITDA.
But the multiple is not set – within the “bankable deal” theory it’s based on cashflow. (Debt service coverage ratio)
Bankability
The bases of any loan are collateral and cash flow.
Collateral
What can the bank put a lien on that they could sell if they don’t get paid?
Most of the time, there isn’t a lot of equipment.
Debt service
Most banks have a minimum debt service ratio of 1.25.
That is in fact very low – Terry would rather see 1.70 ratios on a 5-year loan.
Accounts receivable days vs. Accounts payable days
Terry had 29 receivable days but 12 days in accounts payable days
So that implies a lot of working capital needed.
That has nothing to do with the cash flow of the company overall.
Cashflow vs. Profit and Loss
Sometimes the owner comes to Terry with low cash movements but a high profit, because the profit was based on bonus depreciation.
Non-financial aspects that affect the value
High working capital needs for the company can make it very unattractive.
Know your value
It’s very important to know what your company/business is worth we’ll before you think of selling it.
For one thing, for most business owners, the value of their company represents 85% of their net worth!
Pensions
It’s tragic if a business owner tells a financial advisor and tell them the business is worth $5M. Then the FA writes a retirement plan on the basis of that value. Fast forward to age 65 and Terry tells them that the company worth $3.5M, -this destroys their retirement plan!
Then you need to take that number and build your team. If you need to add $1.5M to the business valuation, you need to develop a plan for this. That’s what Terry’s CEO2CEO programme is there for [link to next episode]
It’s so so much better to see that coming year before and make sure you’re on the right track.
Look at the trend
Over 3-5 years’ data, what is the cash flow trend?
There are normally three scenarios:
- It is a close-range between each one
- There is a steep trend upward
- Sadly, you may have the “glider” path downwards, which often happens if the CEO took their foot off the gas a few years ago.
It’s not fair to use an average if you have a sharp incline or sharp decrease. You need to value the future cashflow.
Purpose of valuing a company
What you’re really trying to do with valuing a company is to predict future values.
A discounted future cash rate can make things look much rosier than it should be.
What you keep net of taxes is what counts!
The big cheque comes along with a big tax bill.
You need to get the right attorney/lawyer who is familiar with Mergers and Acquisitions.
A general lawyer/attorney will not be good enough in this critical situation.
How to learn more from Terry:
BOOK – “You don’t know what you don’t know”
Everything you need to know to buy or sell your business
Free business valuation
Also, check out their website:
Watch my full interview with Terry Lammers
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