Lesson #1: Know the Value and the Potential Market Price of Your Business
Preparedness can never be overemphasized. Many family businesses have shareholder agreements (also known as “buy-sell agreements”) that establish a price or a pricing methodology among shareholders for events like death, disability, withdrawal from the business, and/or termination of employment. But the pricing model for these agreements may bear little or no relationship to the market value of the company if sold in an arms-length transaction.
Market value and pricing may involve valuation professionals, investment bankers or accounting professionals who can educate management on different valuation models applicable in a particular industry. For example, in some industries a business may be valued at a multiple of earnings or EBITDA; in others, the best model is based on return on investment. In real estate businesses, underlying portfolio assets may be the key factor in business valuations. In high-growth technology businesses, valuations may be based on aggressive industry standards as a function of intellectual property rights or the strength and experience of the management team, even if profits have not yet achieved stable levels.
There is a reason why we differentiate between market value and price. Value can be calculated based on metrics, industry expertise and mathematics; market price is a function of what a willing buyer is prepared to spend in order to acquire the business, and may be based on factors totally different from those utilized in a valuation methodology.
A forward-thinking business owner keeps track of the value and potential market price of the business, even if no sale transaction is being contemplated in the foreseeable future. Doing so can assist the family ownership in evaluating the short-term and long-term financial returns in maintaining the family business. It also means that the owners are well prepared if and when an unsolicited offer to acquire the business is received.
Note: On March 1, at the DWT offices in Seattle, Washington, the author and Matt Loftin, a DWT estate planning attorney, will participate in a panel presentation sponsored by the Association of Washington Business on “12 Most Common Mistakes to Avoid in Selling Your Business." This Lesson #1 will be discussed, along with other common seller mistakes. You can register for the presentation by clicking here.
Keith Baldwin is a business transactions and securities lawyer with a forty year history of serving clients’ legal needs. Keith focuses his practice on business relationships, including mergers and acquisitions, agreements among owner-entrepreneurs, and best practices for corporate governance. Keith can be reached via email at [email protected] or directly at 425.646.6133.