Over 99% of American businesses close their doors without any consideration of being sold.
What is your exit plan and what can you do today to make your business more valuable in the near future?
Tune in to hear business performance and valuation expert Rodger Stephens answer questions about the potential sale price of your business today, and what it could be worth over the next few years.
Learn more about my guest by visiting his profile on LinkedIn: https://www.linkedin.com/in/rodger-stephens-cpa-cgma-04a7b124/
Or at his website: https://prize-performance.com/
You may also reach out to him by email at: rodger@prize-performance.com
What follow is a computerized transcription of our entire conversation. Please excuse any typos!
Frank Felker
My guest today is Rodger Stephens, who’s a business performance expert and CEO of Prize Performance LLC, here in Alexandria, Virginia. Rodger Stephens, welcome to the program.
Rodger Stephens
Thank you, Frank.
Frank Felker
Today, we’re going to talk about selling your business. And this is a topic that apparently many business owners don’t really think about. And I’ll tell you why it is. And I say that, in my book, Unlocking The M Cube, by talk about the fact that, you know, we often hear that 50% of businesses fail in the first five years, and so on, and so forth. And I’m not really sure exactly how tight that statistic is. But from one measure, which is whether or not you successfully sell your business, when you decided to move on and do something else, over 99% of American small businesses are failures. And let me tell you, where I get that figure from, according to Forbes. Every month, on average, in the United States, 623,000 companies are founded. But according to a website called biz buy, sell calm, that tracks business sales across the country, only 7000 businesses are sold every year. That’s less than far less than 1% of the number of founded.
Why Do So Few Business Owners Consider Selling Their Businesses?
Frank Felker
So I would like to start with this, Rodger. That’s an astounding statistic. When you think about it, why is it that you think that so few business owners even consider selling their business?
Rodger Stephens
Well, Frank, a lot of business owners look at their business as a job or as an activity or as an income. And it would help them dramatically if they can look at that business as a means to an end of retirement. Right now, there’s a lot of statistics out there about why these businesses are or are not selling.
And right now, the big trend in the business sales market is the baby boomer generation. It’s the baby boomers who are running companies in many places, many states around the United States. And these baby boomers are approaching retirement age. They have great businesses, their businesses have served them well over the many years. And now it comes time to plan and prepare for their exit. And that exit can have many forms. Selling is one of them.
Frank Felker
I guess, but my question would be why aren’t they considering that? Why do so few people, it almost seems as though they don’t even believe their business could be sold, they don’t even consider it.
Rodger Stephens
Yeah. So sometimes what happens is they don’t understand what the value of their business is, it’s not always easy to figure out. But if you can figure it out, you can realize and achieve the retirement goals you’re looking for. And so looking at your business, and whether or not it’s generating income, that’s your main factor there. The businesses that generate income always carry a value, it’s a matter of how much if you’re not carrying generating an income, then the business is probably not going to do so well and not survive.
Frank Felker
And that makes perfect sense. If the company is insolvent, then, you know, nobody wants that nobody’s going to pay for that. And I do believe that that extreme variance between those two figures of the number of companies founded in those sold has a lot to do with the fact that a very small percentage of the company’s founded ever get to the point where they’re profitable, and generating a steady income. But you know, outside of the company being insolvent or not generating revenue or not generating profit. Are there any other reasons why a buyer not would find a particular company purchaseable?
Rodger Stephens
Yes, if a company has a bad reputation, if the company just isn’t viewed well by their customers, or if the company just is generating a profit, of course, that’s the main reason why. However, if their employees have a high turnover, if their products or services aren’t doing a very good job, or in other words, could be drawing ire from their clients or lawsuits from other people, obviously, that club business would not be very viable.
Frank Felker
Now, I know that your business model the service that you provide, is providing valuations for going concerns and also helping those companies to improve what their valuation might be over time. The performance that’s where your business performance It’s expert status comes in. Nonetheless, you know, before we get into how you create a valuation, the types of valuations that you do, can you tell me just is there really such a thing as a rule of thumb of what someone’s business might be worth? For example, I often heard that a figure of one times last year’s revenue, or three times last year’s profits might be a reasonable rule of thumb for predicting evaluation. What’s your reaction to that?
Rodger Stephens
Yes, it’s a good approach to take. What I would say is this rule of thumb actually applies to the smaller business market, that would be businesses under $5 million in annual revenues under $1 million. In what I call EBITDA, or earnings before interest, taxes, depreciation, and amortization. those particular businesses are very often sold with simple multiples. Most of the time, those multiples are about an EBIT, da, but they can be other things such as sales, or perhaps other metrics.
Why Are Larger Companies More Likely to Sell than Smaller Ones?
Frank Felker
Well, and you know, it’s an interesting thing, when we talk about that all at once. It let’s just say we have those two figures, we know what the top line revenue is. And then we have a rule of thumb that perhaps this business, it’s under 5 million in revenue, could sell for whatever that top line revenue number is, just as a rule of thumb, it’s so many variables, and you’ll speak to that a little while, it just seems shocking to me that a company or a business owner would just decide that, you know, on February 23, we’re closing the doors and move into the lake house. And they wouldn’t even consider selling it, when six, seven figures of potential sales value could be realized. I just find that shocking.
And one thing that you said, and you just mentioned the levels of revenue, is that companies or business owners whose companies have lower revenue, under 5 million, are much less likely to consider a sale, and those with 5 million or more are much more likely. Why do you figure that that’s
Rodger Stephens
that’s because a business is worth $5 million a year are actually proven themselves over time and have grown to thresholds that prove management as well as the products and services they offer. And that makes them marginally more valuable than the customer, excuse me, the companies that are under $5 million a year. Now, let me throw out an actual range to use for those companies that are under $5 million a year in revenue. In most cases, in most industries, and this is an industry specific situation, you can reasonably expect to see a valuation between two- and seven-times EBITDA for most industries, this isn’t exactly perfect. But for most industries, you can expect your company to be valued at two to seven times your EBITDA. And that can mean a lot of things.
So let me just run a quick set of numbers. If you have a $5 million company in revenues, you have a million dollars in EBITDA, two to seven times means you have a 2 million $7 million value on average, it’s not exact, it’s not perfect. It’s not something you can go to market with. But it is something that you can rely on as a ballpark figure. That’s a considerable amount of money. And you scale that down to 500,000. For example, you could be looking at 1 million to three and a half million dollars, for example. So the dollars can be larger than most people believe. And you can capitalize on those anytime you choose as a business owner.
Frank Felker
As I say, we will talk about the valuation services that you offer and what’s involved and what somebody might expect. But in terms of let’s just say somebody at $5 million top line that the first illustration you gave, and they were looking at $2 million sale price, everybody has a magic thought that somebody is going to stroke a check for $2 million, and they’ll pay their capital gains. And then though, you know, live happily ever after. Isn’t it true that an all cash purchases is very rare.
Rodger Stephens
It is it’s on the low probability side of how a deal is structured. When you sell a business. The high probability scenario says that you’re most likely going to have some blend of cash and financing involved. It’s inevitable financing has a slew of possibilities that we can talk about in a little more detail if you like. But those are the two scenarios low probability being an all cash and walk away on the spot. A high probability is business owners going to stick around for 12 to 18 months and there’s going to be some financing involved and there’s going to be a gradual transition of both knowledge and capital as the transaction progresses and the transition becomes successful.
Frank Felker
Great. And so what you’re referring to there? Is that what’s known as an urn out, or is that part of it? What what is in her now?
Rodger Stephens
Yeah, there, there are many scenarios to this financing and an urn out means that there is financing involved. And the payments of the financing are conditional based on future performance targets. That could mean certain revenue targets, certain EBIT targets, for example. And as you hit those targets, the selling party gets qualifies for the next payment or the next tranche of funding to satisfy whatever amount of transactional balance they’re financing.
Frank Felker
Now, what about the idea of, you know, we often think that somebody’s an individual, maybe a high net worth individual would come in and buy your customer, a company. But isn’t it also the case that frequently, smaller companies, or even larger companies are acquired by other companies, they’re sort of absorbed their client list their plant equipment, their intellectual property, and that sort of thing, is just sort of injected into another company? How frequently does that happen?
Rodger Stephens
That does happen, it doesn’t happen all the time. It happens in a, I would say, maybe a third or quarter of the time. And under those situations, there’s something that the target company has at the acquiring company needs and wants desperately. And I’ll give you a classic example from a client of mine. Several years ago, I had a client in the chimney sweeping industry. And they had some great services around cleaning and servicing and repairing and refurbishing chimneys. In that situation, they had a great client base in a specific region. Under one strategic scenario, if a company were to come in and acquire this particular company, in a strategic way, they might be a company from another city, who decides they want a foothold in our city, and they do not have one yet, so they can purchase a company to gain that foothold. That is one way to do it. It could also mean that that other company that’s acquiring is a masonry company, for example, and they want to acquire a chimney sweep so that they can expand their suite of services. That would be a second example of a strategic acquisition.
Frank Felker
That makes sense, I understand what you’re saying, what about this, this happens at some frequency, your company is acquired by a public company, and they might want to pay you, in part or in full in shares. How would you react if one of your clients came to you and said they’d received an offer like that?
Rodger Stephens
I would very much encourage them to take that offer seriously, because these public companies and I’ll throw out some statistics, but they generally run their companies in a far more efficient way than the smaller privately owned company. And I’ll give you some statistics as a specific example. Larger companies are known to have between two and 4% of fat in their expense or cost structure, where the private company very often has 20 to 40%, fat or lost in their cost structure. And so it’s very, very attractive for a public company to come in to a small or privately owned company and buy that company and issue their shares. Therefore, with the way that they want their companies as a public company, you as a receiver of the shares of that public company could very easily benefit handsomely, not just for the price of your company, but for the future appreciation of those shares.
Why Would a Business Owner Ask for a Valuation?
Frank Felker
Well, that’s a great point, how that public company could then leverage their purchase of you by squeezing up at 38% of fat. And then everybody benefits because the value of the public company goes up, which increases the share price. That’s really neat. I never thought about that. Now, you’d let’s talk a little bit about the services that you provide. A company will come to you a business owner comes to you and says, I need to find out what my company’s worth. Now, clearly, maybe they have an offer, what have you but what are the reasons why a business owner would come to you and ask for a valuation?
Rodger Stephens
Yes, first of all, those business owners that come to me are largely privately owned businesses. And they are very often in a wide variety of situations. I’ve had companies come to me that say, you know, one of my relatives passed away, they own this company, I’m inheriting their shares, and I need to know what the shares are worth. That’s considered a state related. I’ve had other companies come to me and say, hey, I want to shift shares around inside the company between myself the current partial owner and another partial owner, that still exists, I want to reward them or I want to reward an employee by giving them shares in the company. And then by doing that, by transferring those shares, anytime a transfer is made, it’s very important to put a value on those shares for that employee’s value of what was transferred at that time. In other situations, it’s a buy sell situation, where a company owner comes to me and says, Hey, you know, we’re considering selling our company. And we need to make plans. And one of the steps we need to do as part of selling our company is to understand what it’s worth. So those are the main reasons why people come to me to look for a business valuation.
Frank Felker
Now, with that in mind, it’s important that they can feel secure, that you know, what the heck you’re doing and what you’re talking about. I understand that you have different certifications and so forth that are based on your knowledge and experience that add additional gravitas to the valuations you deliver. Can you tell us a little bit about that?
Rodger Stephens
Yes, valuations are based primarily on your EBIT, da, that’s the number one factor for what the outcome of your valuation looks like. There’s more to it than that again, EBITDA being earnings before interest, taxes, depreciation and amortization. There’s a lot more to it than that. But that is your number one driver of what your valuation actually is going to look like. And if your company has three years to five years of history of growing revenues, and growing profitability, and growing cash flow, that’s your ideal scenario. Those are some of the best-case scenarios.
But I obviously have other clients who come to me saying, Hey, I’m in a, I need to retire, I’ve had a little bit of a health crisis, I need to leave now. People want to step out of their business relatively quickly. And they may or may not have time to prepare. Sometimes that happens. But my background is about running companies. Early in my career running finance departments, in large public companies in the second leg of my career was about running information systems for large public clients around the country while I was working at both Oracle and Cognos under the umbrella of a Enterprise Planning, excuse me, an Enterprise Performance Management system that helps these companies to look at their financial situation, and operational situation and drive forward by modeling their business and determining what their future performance would be given the assumptions that are within their business of how they’re operating.
And you can play you know, what if scenarios with that just as much as you can look at your actual performance. And what I do in that area in is, I take that as a key element of a business valuation. And I put that into the context of a business valuation, because one of the key elements of the business valuation process is to project forward if five years in time to determine what their future outlook probability looks like.
Frank Felker
And that’s so that you help with as well as is helping them do everything they can now and in the near term, to increase their valuation going forward. What sort of things can a company do to help improve that?
Rodger Stephens
Yeah, one of the things they can do is really, really helpful thing they can do is to plan ahead, because this is a multiyear process, if you’re able to plan ahead, and you’re able to plan and and execute on three to five years of great company performance, and you’re doing extremely well. Now, there are other things you could do to help bolster that one of those things is you keep a very clean set of books that are very transparent, because a buyer is going to come in and look at your books very carefully. That means if you have an internal accountant or an outside accountant, or if you have audited books, those all helped dramatically. If you’re following generally accepted accounting principles or gap, that also helps dramatically.
Other things you can do is to have things like highly reliable income. That means having agreements with your customers that ensure a generous long term income stream, done by a written contract, where the customer has agreed that they will pay you or your company a certain amount of a certain amount of revenue over a certain period of time with renewal, you know, renewal clauses, for example. Those all help bolster the strength of your income stream. Because remember, it’s the income stream that makes a difference. Here are the biggest difference on your business valuation.
Is a Long-Term Lease a Benefit or a Detriment?
Frank Felker
Isn’t it true, also, that having a long term lease in place for your manufacturing plant or your retail store, that sort of thing? Is is a benefit or adds to the value? I always heard that but I always thought well, is that really a benefit? Because it seems to limit your flexibility. How do you look at that?
Rodger Stephens
Yeah, I look at that as another double-edged sword, a long-term lease could be a good deal and a long-term lease, but it’s relative to the market. One of the things I do in a business valuation is to judge whether or not a business is paying market rates for these leases. And what I try to tell my clients is, this lease is very helpful if you have a little bit of flexibility in raising or lowering that lease according to how much space you need, or what the current market rates are, if you have that flexibility, then you’re in a little bit of a better position. But if you don’t have flexibility, and you’re playing a significant lease rate, and that lease is actually going more and more expensive, and may not be to your benefit to have a long-term lease, if your lease rates are driving higher and higher at the market might be out of sync with that. So the lease has a double edged sword very much.
Frank Felker
I’m glad you agree that I actually I always saw it as more of a hindrance. But in any event, there’s clearly two ways of looking at him. Now, when you’re doing your evaluations outside of the financial statements, you also look at things like how competitive the marketplace is that this company is in both geographically and and industry wise, and also how future technology might impact this not only this company, but the whole industry that is in the look at exogenous variables like that.
Rodger Stephens
I do I look at what systems the company is using, I look at the composition of their clients, I also look at the market around the company and determine where this company’s placement is in that market. Is this a an in demand industry? For example? What are the industry statistics say? Or what are the I often draw the industry performance metrics for the industry as a whole and compare them to what the client is doing so that a buyer can look and see? What do those statistics comparisons look like? Is their EBITDA better or worse than their industry? And in that case, we’re using the metrics of net operating margin and using the percentages of revenue in order to determine Are you earning a better percentage of revenue? EBITDA than industry as a whole? If you’re doing that, that adds value to your business?
Frank Felker
Now you have three different levels of service that you provide in terms of valuations. Could you tell us what those three are and give us a little insight into each?
Rodger Stephens
Yes, what I’ve done is I’ve constructed three different kinds of valuations. And these are intended for different situations. And I’ll take a moment or two on each, but let me just give you the three. First of all, for the smaller business or the business who needs to grow, especially in the growth area, I offer a package that is what I call a valuation light, it uses one method, it’s a simple method, and it’s only an approximation of value. It takes a number of things into account. And it provides the business owner with a ballpark value. It’s intended for a business owner to grow their business going forward. If the nature or if the situation warrants it, I’ll provide the business owner with some sort of alternate forecast scenarios with accompanying alternate valuation so that they can grow their business over three to five years, for example, with a reasonable estimate of what their valuation would be when they reached the end of that road, and they make those target metrics of revenue and EBITDA.
The second package I offer is a what I call a formal valuation. It is intended for business in the buy sell situation, and it is meeting all of the standards of the AICPA in the A sa there are two different business valuation standards there. And because it meets those standards, it actually holds up to scrutiny in the buy sell marketplace, and it lends credibility to both the buyer and the seller. It’s much more precise, it’s actually much more accurate. And it takes three different valuations and blends together in order to come up with both a range of figures and a single figure for the value of the company. Those three valuation methods include both market methods, as well as the income methods. So we’re looking at a much more precise way of setting this up. On the third option, we’re talking about what I call a business condition assessment. Again, this this includes the business valuation from the second option, but what it also includes is additional analysis, expansive analysis that profiles the health of the company. Those business owners who are In the buy sell marketplace with their business, who have a healthy business can actually promote and illustrate the health of their business to a potential buyer or seller. And I can provide them with the independent analysis and insights in order for them to see and understand where these benefits and health pockets are in the company, and promote a company for sale in such a way that we’re still adhering to the methodologies and standards of the formal methodology or excuse me, the formal valuation. So those are the three pieces that I offer. And again, they’re intended for different purposes.
Frank Felker
Can you tell us how long the process is for each of those three different approaches?
Rodger Stephens
The process actually isn’t that long, I normally take roughly five to 10 business days for any of those three options. There are some other providers out there that do dramatic take dramatically more time, I tried to turn them around within five to 10 business days, because I know that a business owner in many cases, I’ve got other events that are going to happen after evaluation takes place. And so I’m able to deliver that valuation relatively quickly in order to meet their schedule.
Frank Felker
We’re just about out of time, Rodger, but I wanted to ask you, if someone’s been listening, or watching and is interested in hearing is interested in what they’ve heard from you, what’s the best way for them to reach out to you?
Rodger Stephens
You can reach me by email at info@prize-performance.com.
Frank Felker
Okay, and it’s info@prize-performance.com. And you’ll and when can they expect that you might to get back to them?
Rodger Stephens
I can usually get back to you within one or two business days.
Frank Felker
I want to leave with this question, Rodger, I’m sure any business owner that’s heard what you’ve had to say here today, their head is probably spinning. And they’re thinking, you know, when do I want to sell? And how much do I need to get to retire? Who knows what they’re thinking of? And then wondering probably the number one thing that one is, what should I do next? What do you think is the best next step that a business owner can take to begin moving towards a successful sale of the company?
Rodger Stephens
Well, they can enlist help. What they can do is enlist the help of someone like myself, who is a business performance expert who also does valuations. This is a unique and custom skill. You can also enlist help with representation. If you’re far enough down the road that you’re ready to list your business for sale. That representation may take the form of a business broker for those small businesses under $5 million a year in revenues. Or it may be an M&A representative for those businesses over $5 million in revenues. But if you’re not ready to list then it would be a good idea to hire someone like myself, to help you evaluate your performance, how much your business is worth and how you’re performing so that you can clean up your books, make arrangements, do other things that you need to do in order to present your business well for sale.
Frank Felker
Rodger Stephens, thank you so much for joining me today.
Rodger Stephens
Thank you.
Frank Felker
Thanks again to Rodger Stephens. And thank you for joining me. Until next time, I’m Frank Felker saying I’ll see you on the radio
