Who’s buying?

When an owner decides to sell a business, the first question is always,
“How much is it worth?” Expecting a magic number or a one-size-fits-all valuation, the owner is frustrated when told,
“That depends.”

“There are lots of reasons to value a business, but when it comes to selling, the parties involved and their unique economic
characteristics and points of view are critical to placing a value,” says Mario O. Vicari
Jr., director in the Audit and Accounting
Group at Kreischer Miller in Horsham, Pa.

The price depends on what buyers are
willing to pay, and there are different types
of buyers who seek opportunities for various reasons.

Smart Business asked Vicari to explain
why buyers value businesses differently
and how owners should tailor their valuation expectations to suit the circumstances
and buyer motives.

Why are there different ways to value a business?

I get calls all the time from business owners who say, ‘I need a valuation.’ The first
question I ask is, ‘Why?’ You may be selling
the business, or you may need a valuation
for the IRS because you plan to make a gift
as part of your estate plan. The purpose of
the valuation and the parties involved dictate how your business will be valued. The
value of a business could vary significantly
depending on the purpose and unique
points of view of the parties involved.

Say an owner is selling a business to a
potential buyer. How will the valuation vary
depending on the participants?

There are generally three categories of
buyers. One is the internal buyer, and that
might be a family member or employee.
The second is a financial buyer, an outside
party, such as a private equity fund that
wants the business for the purpose of creating returns for investors. The third type
is a strategic buyer. This buyer is typically
in the same industry as the business owner
and has unique reasons, at a strategic level,
for wanting to add the business to an existing enterprise. Some of those reasons may
include taking advantage of operational
synergies or gaining market share. Each of these buyers’ motives vary, which means
each will value a business differently and
approach the sale with different goals.

How might a valuation play out for an internal buyer?

An internal buyer usually has an emotional attachment to the business. The
buyer is already committed to the business
as a long-time employee or as a family
member. This buyer typically plans to continue working in the business after purchasing it and usually intends to hold it for
a long time to continue his or her career or
the family business legacy. The internal
buyer is typically the most conservative
from a price standpoint because of a lack
of capital. That shortage of funds makes
this buyer’s cost of capital high because of
the need for personal guarantees and the
investment of life savings to fund a transaction. In doing this, the internal buyer
takes on a significant level of personal risk
in funding an acquisition and, therefore,
cannot afford to overpay for a company.
That said, an owner still may choose to sell
to an internal buyer if he or she is motivated to control who buys the company.

What about the financial buyer?

A financial buyer looks more strictly at the numbers and the long-term growth
potential of the business as an investment
asset. This type of buyer is typically a private equity fund, which raises capital from
investors. This capital is deployed to
acquire businesses that will provide
returns on capital in the future. The financial buyer’s principal concern is to get a
certain level of ROI for investors. This
buyer usually supplies growth capital and
management to the company to help it
grow much faster than it could on its own
and typically establishes a time frame for
reselling the business to maximize returns.
While the financial buyer will typically pay
more than the internal buyer, the requirement to provide ROI for investors ultimately dictates the price.

Why is a strategic buyer willing to pay the
most?

A business likely will hold the greatest
value for a strategic buyer who has very
unique reasons why the business fits with
his or her current strategy. These reasons
could include geographic expansion,
increased market share, line extensions,
access to new markets and the elimination
of a competitor. A strategic buyer is often
in the same or a related industry as the seller. This buyer sees the business as having
synergistic value when combined with an
existing business and, therefore, as having
significant value. This buyer tends to keep
businesses purchased to increase the
worth of an existing business. For that reason, a strategic buyer is usually willing to
pay a high price to acquire a business.

What should business owners consider
before they get a business valuation?

Ultimately, there really is one value for a
business, and that is only realized when the
buyer and seller shake hands and make a
deal. However, up to that point, the unique
facts and circumstances of every case —
the seller’s motives, the buyer’s cost of capital, the quality of the business and its performance, among many other things —
drive the outcome of the valuation.

MARIO O. VICARI JR. is a director in the Audit and Accounting
Group at Kreischer Miller in Horsham, Pa. Reach him at (215)
441-4600 or [email protected].