The US economy was especially hard on local small businesses in 2009. Most saw sales (and the corresponding value of their business) fall dramatically. But in every economy, there are companies whose better days are behind them. This can be due to a mature product line, holding too much corporate debt, new or increased competition, exhausted management or all of the above. When profits are steadily declining (or non-existent), what options does a small business owner have to value the business for a sale?
Most businesses are valued using an industry multiple (typically 2-3) times the owner’s free cash flow; however, this is an optimistic approach which assumes the business is healthy with positive historical growth. It is likely the comparative companies used in calculating the industry multiple were growing and historically profitable firms. Therefore, in order to account for the current state of the business, additional steps are needed.
There are three (simplified) ways to value a declining business for sale.
1 – Simply apply a discount (20-30%) to the calculated value from a multiple of free cash flows. However, the discount amount is an arbitrary number which is difficult at best to justify.
2 – If the decline is reversible (by having better management, more cash for operations, etc), the business may be valued based on a forward-looking financial analysis. An owner could conservatively predict the next 12 month’s revenues and expenses, calculate the free cash flows of the business and apply the industry standard multiple for healthy businesses.
3 – If the decline is not reversible, the business may be valued based on the tangible assets owned by the company. The goal of using this approach is to the get best possible price for the hard assets of the business. An owner should add the current market values of inventory, raw materials, furniture, fixtures, and equipment to arrive at the total market value of the business’s tangible assets. If this value is higher than #1 or #2 above, then the parts of the business are worth more than the whole of the business. This is a sign the owner should liquidate by selling the assets separately instead of proceeding with a sale.
Regardless of the method you choose, if your business is steadily declining you should be prepared to price it aggressively. There is no sense ‘following the market’ downward over time – every moment chasing prospective buyers potentially reduces the price even further. Be a realist, price the business to sell and move on to your next, and hopefully more profitable, venture.
