With so many small businesses being bought and sold, and record numbers of people quitting jobs and starting new businesses, we thought it would be a time to sit down with an accredited expert on business valuation and dig into the art and science of placing an accurate value on a small business. In this episode of the Small Business Matters podcast, Richard Goeldner from FairValue Advisors shares his expertise.
What follows is a lightly edited transcript of our talk.
[Gary]: If you were thinking of buying or selling a business, 2022 is shaping up to be very busy. According to BizBuySell’s Insight Report, a leading resource that tracks and analyzes businesses for sale. The number of businesses being bought in Q1 2022 grew by 24% over the previous year; this watermark comes in just 3.7% shy of Q1 2019 before COVID-19 shocked the market. The market of buying and selling businesses has been rising at a steady pace since dropping 39% in Q2 2020. Whether you’re buying a business or selling a business, value matters. So, for this small business matter, we will be speaking to Rich Goldner. He’s an accredited senior appraiser who has provided valuation advisory services since the early nineties, and he specializes in the valuation of privately held companies and intangible assets. Rich has worked with a wide range of companies from fortune 500 companies, family businesses, as well as private equity firms, M&A firms, and the IRS, and made numerous public appearances on the topic. His writings on business valuation issues have been published in local business journals and the business valuation review. Rich, welcome to the small business matters podcast.
[Richard]: Thanks, Gary. Thanks for having me on.
[Gary]: Well with so many people taking the opportunity to quit their day jobs during the pandemic. Are you seeing people buy businesses or do you think they’re starting their own?
[Richard]: I think I’ll say it’s a tough question. I certainly believe that they’re buying businesses, you know, starting businesses in this environment. Certainly, I think has been a challenge particularly given the economic conditions, although as you cited earlier, you know, the conditions are improving in terms of business transaction activity.
[Gary]: For a small business owners listening and who are considering selling their business. What are some of the biggest mistakes that you see business owners making prior to a sale?
[Richard]: With business owners, I would say a lack of preparation is probably the biggest mistake in many smaller businesses. The business is so dependent upon the owner, and if there isn’t a second level of management, a middle management, the risk to the buyer can be quite significant because once that business is purchased, you know, are the customers going to stay are the employee is going to stay? And oftentimes that owner is the glue that makes that business really stick. So, putting plans in place and building out your management team well prior to selling your business, I think can certainly pay dividends. Another area is customer dependence. If you have a business that is dependent upon one or two customers for you know, 30 to 50% of your revenue, that’s going to be viewed as significant risks to a potential buyer.
[Gary]: So, you want to really be building that business so that it can be assumed by somebody else. You don’t really want to have yourself so entangled with it that it’s going to fall apart whenever the sale is made. Is that what I’m hearing?
[Richard]: Exactly. Exactly. And with those risks that translates into a lower price multiple, and a low, usually a lower offer for the business or some kind of an earn-out where the owner is obligated to stay on for a longer period of time to ensure a smooth transition. And of course, many business owners, the reason they’re selling their business is they don’t want to do it anymore. So again, it can be a little problematic.
[Gary]: When I watch Shark Tank, as I’m sure you have, the sharks always mention this formula for calculating business value. Can you explain that to us a little?
[Richard]: Sure. Yeah. I love shark tank and you know; I think one of the price multiples that they will bat around on the show is a multiple of revenues. And sometimes the numbers are really, high, like, you know, 20 times revenue, and, you know, most smart investors like the sharks, they’re not buying revenues. You can’t put revenues in your pocket. Investors are buying, you know, the profits or the future cash flows of the business. And on Shark Tank, you’ll see that the sharks are jotting down notes in their little black notebooks, their little note pads. And we don’t get the benefit of seeing exactly what they’re thinking or what they’re jotting down, but they’re probably estimating how long it’s going to be until those businesses become stable and earn profits. And they’re looking at discounting what that value might be for the risk and the amount of time needed to get that business to stabilization. Now, the example that I just went through is for a business that’s young and a lot of the businesses on Shark Tank are very young businesses. There are times when a more mature business will come on Shark Tank for various reasons. And you’ll note that at that point, the sharks are talking about a multiple of profits EBITDA, for example, which is earnings before interest tax depreciation and amortization, it’s a profit measurement, and they’ll be talking about a multiple of earnings. And that’s more common in the valuation of businesses and in the sale of businesses. Again, unless you’re talking about ones that are more of a startup, of course, also with the sharks, the sharks know that they have the backing of, of their name and their experience. So, the businesses that they’re investing in, you know, generally have a greater chance of success as well.
[Gary]: Yeah. So, so what methods, when, whenever you go into value of business or appraise a business, what methods are a commonly used?
[Richard]: Sure. There are three approaches really, which are like the approaches that are used in real estate appraisal. The first is a cost or asset-based approach, which estimates what the business would be worth if liquidated. Think of the going out of business sale, you know, turn out the lights, the party’s over. This approach gives very little value or no value to the good will of the business or the intangible assets like name, reputation, customer relationships, you know, the existing personnel. So, the cost approach is typically appropriate for businesses that are in financial distress, where a buyer simply isn’t going to pay more than what the hard assets are worth. So that’s approach. Number one. The second approach is a market approach. And we were talking about Shark Tank and multiples of revenue or profits. And that type of approach is a market approach where you’re estimating the value based on comparing the business to similar businesses that have sold. And this is frequently called a price multiple. Again, multiple profits, which is more popular than a multiple of revenue. And then the third approach is an income approach, which estimates the value by basically estimating the future profits and cashflow of the business in the future. How much could this business make annually? And then discounting those cash flows to a present value based on the risk involved in achieving those expectations. And with this approach, I would say, think of a time value of money concepts. For healthy businesses, that market approach and that income approach are going to be the most frequently used. And of course, finding good data about businesses that have sold can be challenging. So, the market approach can be a little difficult at times. You could say that businesses that are unique can be very valuable, but businesses that are unique will probably not have very many comparable businesses that have sold.
[Gary]: So, what drives the value of a business?
[Richard]: I see really six factors that drive the value of a business. One is revenue growth. You know, you must have revenues to get the profits, right?
[Gary]: Yes.
[Richard]: And profit margins, are they stable or improving? This is when I say profit margins. I mean, as a profits, as a percentage of revenue, is that stable or improving over the years? Asset utilization or asset usage. That’s our third key factor. You generally must reinvest more of your profits in asset intensive businesses. These would be businesses that have perhaps a lot of machinery or equipment that needs to be replaced frequently. Those will tend to have a lower price multiple because you’re not able to take out as much of the profit into your pocket each year. And then there is a debt leverage. You know, some business owners are very aggressive with the use of debt. They have too much of it. And some business owners elect not to use that very much. And so, for those that are very light on debt that increases business value. And of course, those that have a real high debt level, you know, the value of the business is going to be lower. And then there is a business risk. This goes back to our conversation earlier about key person dependence or customer dependence. Those are examples of business risks that will impact value. And the last one we really don’t have much control over and that’s market conditions. Are we operating in an economic recession or perhaps in a growing economy? So clearly, you know, having lived through the COVID recession and I realize COVID is still with us, but you know, the economy has certainly bounced back, but you know, market conditions and the timing of that is really a factor that impacts value, but we really don’t have that much control over it.
[Gary]: Yeah. Marcus Lemonis from “The Profit”, he appears to have a sixth sense when it comes to valuing businesses, he’s looking to invest in, what do you think we could learn from him?
[Richard]: I love Marcus, I love the show. He preaches People, Process and Product. And when he goes in to look at a business, usually one or more of those three issues, one or more are broken, either the people, the process, or the product. And if one of those three is broken, it depresses profits. And obviously you end up with a business that could be in distress. And that’s where Marcus comes in. So, in many cases, Marcus finds the people relationships to be broken in some way. And so, in many of his shows, you’ll see, he’s trying to sort out the dynamics between family members and between employees to see what the problems are from a people perspective. And to see if he can fix those. Sometimes he finds processes that are inefficient or inconsistent where the quality, you know, just isn’t there every time. And of course, he also looks at products to see whether those products are serving the customer’s needs in a good way. And so I like his people, process, product mentality.
[Gary]: Yeah. He seems to approach things with a great deal of empathy. I mean, when he’s having those hard conversations with the owners or partners, he has a way of just putting things out there in a plainly spoken way. He isn’t afraid to have the hard conversation and keep it real. And I love the show too. I think we could all learn a lot from, from him just by watching.
[Richard]: I’d say it’s amazing how he’s able to diffuse situations. He really, really does a great job.
[Gary]: So, you’ve been involved in valuating businesses and appraising businesses for some time. Is there a business that stands out to you maybe as the most interesting or most unusual that you had your hand in a buying or selling?
[Richard]: The most interesting? Boy I’ve had several. I’m going to go back to one that was very early in my career, a business where the owner died and the son inherited the business and he was an attorney, the son, and he wanted to go to seminary to become a priest, an Episcopal priest. And he hadn’t shared that with his father before his father died. And this business has landed in his lap, and he didn’t really know much about the business or how to run it. And so, for about a year after his father died, we watched the business just gradually decline. And it was very sad to see. It was a company that specialized in cleaning manufacturing equipment in a particular sector. And so, I found the niche to be very interesting in terms of the type of business it was, but it was really the story of what happened to that business that stands out the most me. And what I didn’t know at the time is they had obviously failed to plan the exit. And nowadays exit planning is very popular. That term is bounced around, but exit planning is something that’s been around probably ever since there’s been a business, but a lack of planning can damage the business and what you’re able to get out of it. And so that’s, that’s why I think of that one situation.
[Gary]: Wow, that’s interesting. My sister-in-law was going to take over a business, a shoe repair business for her father, and she did it for some time. She was taking real estate classes at the time, but she was known as the Huntington Beach Shoe Lady. Her business cards had the shoe, “The Lady That Lives in a Shoe”, but in the end it was not a fit for her really for environmental reasons because California was changing the regulations on the glues that you can use to repair shoes. And those types of things just became a very regulatory, I guess, risky place for her to be operating. And she got her real estate license and has now got a thriving real estate career. So sometimes the business, you know, just may not be the right fit for a variety of reasons.
[Richard]: Absolutely. And the example you gave, one of the major business risks was a regulatory risk.
[Gary]: Yeah. So, any closing thoughts for small business owners contemplating selling or, or buying a business?
[Richard]: Sure, sure. I would say, for many owners, your business is your most asset, but you won’t find the value of your business listed on your brokerage account statement. And so, if the real value of your business matters to you, I recommend investing in getting a business valuation, a formal business valuation so that you know where you stand and you can do that well in advance of selling your business. You don’t need a business broker if you’re looking at selling in, three to five years, but you might want to know where you stand now so that you can look at ways to improve the value of your business over the next few years, as you prepare to sell.
[Gary]: Excellent advice, Richard Goeldner, where can people learn more about you?
[Richard]: Well, simply search for FairValue Advisors online. You’ll find our website.
[Gary]: Awesome stuff, Richard, thanks so much for coming on Small Business Matters and sharing your knowledge with us we really appreciate it.
[Richard]: Thank you so much. I’ve enjoyed it.
