Rules of Thumb are used every day to help business owners place a sales value on their business. These “rules” are quick, simple and easy to apply; however, they are only the beginning in the process of determining a business value.

Many of these rules belong in one of two categories:

• A multiple of gross revenues (sales)
• A multiple of earnings (net income, cash flow, EBITDA)

The value derived from these “rules” is the value of the operating assets of the business plus goodwill. The price does not include cash, accounts receivable, work in process, prepaid expenses and real estate; these will be retained by the seller. It also assumes that the business will be free and clear of all debt and accounts payable; these will be paid by the seller.

Business Valuation Resources has identified “rules” multiples of gross revenues for major industry groups in recent years:

Industry                     2008           2009          2010

Construction              0.39            0.40           0.35

Manufacturing           0.53            0.61           0.52

Transportation           0.69            0.43           0.55

Wholesale Trade       0.46            0.45           0.52

Retail Trade               0.36            0.33           0.34

Services                     0.56            0.53           0.56

These “rules” are very useful tools; however, they are often misunderstood and misapplied.

According to the results of the PPCMP (http://bschool.pepperdine.edu/), business owners reported having increased enthusiasm about their company’s growth plans, but almost one-half of them reported the lack of necessary financial resources to successfully execute their growth strategies.

There have been about 250 bank failures since the start of the financial crisis in 2007 and with hundreds of additional bank failures expected over the next few years, business owners may be unable to finance or refinance their needs through traditional sources: senior cash flow lenders, asset based lenders and mezzanine funds.

The PPCMP reports on the current climate for accessing and raising capital from not only traditional sources, but also private equity groups, venture capital firms, angel investors, factors and family and friends. The ongoing research includes; the conditions influencing the decisions of each group, provides the cost of capital in each market segment and helps growing business owners make better financing decisions.

The available pool of alternative capital represents a unique opportunity for the business owner to step outside their normal comfort zone and explore new arenas of commercial financing in these challenging times.

Before approaching any source of capital, the absolute “must” is a well-prepared business plan that documents how the funds will be used, secured and paid back!

The value of your company is in the eye of the buyer; therefore, sellers of middle-market companies should position their businesses to drive the strategic value and attractiveness before a possible sell transaction. Enhancing the value of your company is an ongoing process; sellers should prepare their company for sale 18 to 24 months before marketing their company. The following actions will help you start the process:

• Clean-up the balance sheet: dividend out extra cash and securities not required for working capital; write-off uncollectible accounts receivables and obsolete inventory; sell off non producing assets; eliminate stockholder and employee loans; and, record all company liabilities such as vacation time and other employee benefits.
• Put “change of control” agreements in place for key employees: the buyer’s perception of value is strongly influenced by the retention of key employees. Incentives in compensation and change of control agreements with key management will help maximize company value.
• Position the company for income and opportunity: Identify the drivers of value, elevate existing processes; control the expenses, do not take excessive compensation, negotiate leases that will not hinder a sale; prepare financial projections for the next few years.

Sellers and buyer’s perspective vary greatly when looking at the value of companies. When it comes time to sell, it is important that the seller consider those factors that are important to a buyer. Buyers look at the expectation of future earnings; then use the characteristics below as risk factors affecting, both positively and negatively, the future earnings potential of a target business:

• Growth Prospects; being in a growth industry places the company at a higher value
• History of Earnings; sustained year-over-year revenue growth is highly valued
• Type of Business and Competition
• Management Team; strength and depth commands a higher price
• Employees; established, reliable workforces demand a premium price
• Customer Focus & Retention; long-term relationships, cross-selling opportunities are preferred
• Diversification; can products be expanded or fill a niche
• Location & Facilities; desirable geographic areas and well-maintained facilities command a better price
• Terms of the Sale; debt financing or equity capital

Certainly buyers and sellers should be aware of the characteristics above as they heavily influence the ultimate value, the time it takes to sell, and sometimes whether a company will sell at all.

Most M&A professionals will warn you that you can’t keep your intentions to sell your business close enough to your vest. Confidentiality in M&A transactions is a serious concern in four areas:

• With employees of the selling company
• With customers and suppliers of the selling company
• With competitors of the selling company and the public
• In cases of a public company, as possible insider information

Two approaches exist with employees:

• The Controlled-Disclosure Approach – relevant information is released in a highly-controlled manner.
• The Surreptitious Approach – very few people are aware of the impending sale.

The seller and M&A advisor may minimize the risk of breach by:

• Agreement on strict rules regarding all transaction related communications.
• Nondisclosure/confidentiality agreements with potential buyers
• Control of the Executive Summary
• An agreed-upon target list of buyers

Keeping the sale a secret is nearly impossible; be prepared to announce the transaction, especially in cases where the word leaks out. A planned announcement by the M&A advisor will minimize the damage of a leak, and prevent potential loss of value or sale.