Podcast 78 Transcript: Business Valuation

Written by Ian Portsmouth

Ian Portsmouth: I
Sue Loomer: S

I: Welcome to the Business Coach Podcast, an advice-oriented series that tackles the top issues and opportunities facing Canada’s small businesses. I’m your host, Ian Portsmouth, the Editor of Profit Magazine. And we’ve developed this podcast in cooperation with BMO Bank of Montreal.

Business valuation is a hot topic in the days following the recession and leading up to the mass retirement of baby boomers who will need to sell their companies. Given those factors, do you know what your business is worth today? And which way its price is going? Here to help answer those questions and to help you maximize the value of your business is Sue Loomer.

Sue is a Chartered Business Valuator and a partner at BDO Canada, and she joins me on the line from her office in Toronto.

Sue, welcome to the Business Coach Podcast.

S: No problem.

I: So Sue, just how much did the financial crisis and the recession affect private company valuations and how much have those valuations come back, if at all?

S: Well many company values were negatively affected by the financial crisis and the recession, in really one of two ways. One, their earnings decreased as a result and secondly, the multiple paid, a valuation multiple paid for many businesses decreased over that time. The degree to which companies were affected in terms of their value based on these two things, but on multiples alone, we’ve seen them come down by 20 or 25% or more, between 2007 and 2009. They’ve come back somewhat but selectively. So, some companies with good prospects, good management, a good story, they will see their multiples rebounded somewhat, but generally not as high as the early 2007 level. Other companies have suffered more because their earning are depressed on top of these multiples having come down. So, you can think of auto parts suppliers, or companies supplying to the US which was particularly hard hit.

I: 25 to 30% of a company’s valuation is a big chunk of change, and I’m guessing that a lot business owners don’t realize their value has dropped that much. What is your best guess of what percentage of business owners actually have a reasonable idea of their company’s valuation?

S: Well there is no statistics out there on that. But there was a survey done in 2008 of business owners who sold their businesses, and of those surveyed only about 33% have gotten a professional valuation before they sold their business. But 74% of them wish that they had done it and recommended to other business owners that they do get one done. In my practice, what I see is that some owners have a rather pessimistic view sometimes and what they would say is, you know, who would buy my business. Therefore they think it’s got a relatively low value. But others assume that they can simply apply the lost in multiples that they see for public companies to their company and they end up with an inflated view of it.

But I think most don’t really have an idea of value. Although over the last couple of years, I am seeing more and more business owners are being more proactive in getting professional valuations done. Often times before they’re even looking at selling their business.

I: Sue, let me just jump back. You did mention that many entrepreneurs have an inflated sense of the value of their companies because they look at the multiples for publicly-traded companies. Is there typically a discount on private versus public, and what would that amount typically be?

S: There is generally a pretty big difference between private company valuation multiples and public company ones. Because private companies tend to be smaller, less diversified than their public company counterparts. So at worst the valuation multiples for a public company may simply not be applicable to a private company, particularly if it’s relatively small private company. But at best, if you’ve got a sizable private company you may need to still discount the valuation multiples you see for public companies by 20% or more. But it really depends on the company and the degree to which you can find a truly comparable company in the public market.

I: Sue, let’s get into some of the key determinants of a private company’s valuation. One of them is obviously going to be hard assets and we probably don’t have to spend a lot of time thinking about that. What about intellectual property, how much is that factor into a company’s valuation?

S: It does impact it. And really there is two parts to a business’s value, and you hit on one of them and that is the value of the hard assets, net of any liabilities the company has. The second piece is the goodwill or intangible assets, which would include things like intellectual property and other kinds of intangible assets. So, the degree to which there is intangible value and how much, is really a function of the cash flows that are generated by the business. The risk profile of the company, so risk factors that are impacting on the revenues and expenses that causes uncertainty, or variability or sustainability of the cash flows. And the third thing that impacts on the value is the market rate of return. So, it’s the combination of those three things that will translate into what if any, goodwill or intangible asset or intellectual property value there may be in the business.

I: Now I’d hate to call it a human being an intangible asset, but many business owners think that their companies are worth a lot, but of course no one will buy them because the people want the business owner to still be a part of the business because they have a lot of knowledge and relationships. How much of a value is placed on the founder and the entrepreneur who has built and grown the business in a typical situation?

S: Well really, the key to making a company valuable and salable is the degree to which you can transition the customer base, the revenues, the profits to a buyer. So if everything is all wrapped up in the head of the owner in terms of the relationships and the know-how, the ability for a buyer to step in and continue the business is lower. So, one of two things that is going to happen, or maybe both, is that, any buyer who is looking at buying the business, is not going to pay top dollar for it, because there is a lot of uncertainty with the ability to have all of those things transitioned to the buyer. The second thing that will likely happen is if they can get comfortable that, you know, I will buy this business because with some transition assistance from the owner, I will buy it. But that could mean that the previous owner will have to stay in the business for sometimes a few years, to help in that transition.

I: And in my experience, business owners typically hate to stay on during those earn-outs or management contracts.

S: Well that’s right I mean you’re becoming an employee at that point and it could be that the whole point of that entrepreneur having started the business was to not be someone else’s employee, that it really is in their interest to try and make sure that this business can stand on its own, without having to have that transition period.

I: Now when it comes to determining the value of your business and actually making it more salable, how important is it to have audited financial statements, or at least normalized financial statements?

S: Well those are two different things. Audited financial statements are really important when you’re trying to sell the business because it gives the potential buyer comfort over the financial statements. If someone looked at it, a chartered accountant has looked behind the numbers and has reported on the financial statement. So, that is one piece. Or the normalization side, that is something that the buyer will do in terms of trying to get out what the true profit of the company is, by doing what’s called normalizing. So, they pull out things that are unusual or pull out things that are not at market rate. So, for example if an entrepreneur pays big bonuses to himself and his family, or her family, that may be one of the “normalizing items” that might occur.

I: Now Sue, one final question. You are a Chartered Business Valuator, obviously you help people determine the value of a business, how do you go about doing that?

S: Well, usually what happens, really the role of the CBV is to gather the information about the business, which will include financial information, like financial statements, tax returns, but also an understanding about the operational side of the business as well, key things around customer relationships, around anything that’s unique about the business, like intellectual property or other kinds of intangible assets. So they take that information, they also get some information on the industry, or the market place that the company operates in. And then also looks at rates of return in the market place. What kind of multiples are being paid for similar businesses, what kinds of rates of return are required by purchasers in the market place. And CBV then takes all of that information and translates it into a conclusion as to the value of the business. And then this is usually set out in a written report that says well, here is what we looked at, here is our analysis, and here is our conclusion as to the value. They really take a research, facts that are specific to the company and then business judgment and it all gets wrapped up into a final conclusion.

I: And how are CBVs compensated?

S: It sort of depends on what role they’re being asked to play. If they are being asked to provide an independent professional valuation, it is generally based on an hourly basis or a fixed fee sometimes. But if the CBV is being retained to help you sell your business for example and as sort of an advisor, sometimes they are paid on a contingency basis a percentage of the sale proceeds, for example. But more often than not, we’re often asked to do an independent valuation where it is really just a fixed fee or hourly based.

I: Sue thanks for taking our questions about valuations and for letting us know how a CBV does his or her job and what they might cost.

S: No problem.

I: Sue Loomer is a Chartered Business Valuator and a partner at BDO Canada. She joined on the line from her office in Toronto.

That’s it for another episode of the Business Coach Podcast. Be sure to check out other episodes which you can download from BMO.com, profitguide.com and iTunes. For other tools to help you build your business, visit BMO.com/coach. Until next time, I am Ian Portsmouth, the Editor of Profit Magazine, wishing you continued success.

Originally appeared on PROFITguide.com