I was talking with a business owner who was considering selling their business of 20 years. The company had served him well, and he had managed to provide a great life for himself and his family.
The challenging part was he was stuck trying to figure out the value of the company he worked so hard to build.
The conversation went as one would expect. He wanted to sell, and he was not sure what to charge. He did not want to leave money on the table, and at the same time, he did not want to have the price so high no one would be interested.
At Innovative Business Advisors, we speak with this type of client often. As a part of our brokering services, we conduct a business valuation to figure out Fair Market Value of the company. One spot to start with any client is to let them know the basic rules for selling a business.
According to the IRS, the definition of fair market value as set forth in Revenue Ruling 59-60 is as follows:
“the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”
When you step back, however, the rule does not give much guidance. Professional appraisers and business valuation experts will have differing opinions of value and valuation methods.
The three approaches to valuations most folks are familiar with are:
- The Income Approach
- The Market Approach
- The Asset Approach
These are great places to start, and while they’ll get you in the ballpark, in some instances, you end up with an over or under-valued company.
For folks like the business owner I was speaking with, the company is not a target of a large strategic acquisition or a venture backed purchase. In fact, the only way the company legacy will survive is if we find an entrepreneur willing to roll their sleeves up, take the leap and get a bank loan to service the purchase.
Then the question becomes, what is the “Bankability” of the deal. Essentially, is its cash flow such that a lending institution will feel comfortable enough to lend the purchaser funds to make the acquisition.
Most banks will tell you there is a simple formula they use when making this determination. It does not involve deep market and competitive analysis, it’s simply a measure of “Debt Service Coverage Ratio.” In effect, when you divide EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization) by the debt service or “Note,” will the company have enough money to make the payment?
If the answer is yes, you have a “Bankable” deal, and after the due diligence, the buyer will likely get the funding they want.
This is a very matter of fact way of determining Fair Market Value. It benefits all parties to the transaction. The Seller knows their legacy will continue, the buyer knows they can afford the risk, and the lending institution is on board as they know the obligations can be met!
When we complete a business valuation, we include our Bankability Method™, which allows you to see if you have a bankable deal.
So, the next time you are considering buying or selling a business, come and talk to one of us at Innovative Business Advisors and let us help answer the question:
“Is this a “Bankable” Deal?”