We lost a prospective client when another M&A advisor indicated that they could sell the prospect’s company for an inflated value that was about 75% more than our opinion of value. (After considerable time, the company did not sell)
The value of a company is what a willing buyer and a willing seller agree is a fair price. Value is primarily related to the risk profile of the investor-buyer, the projected return on investment and the alternative ways that the buyer could invest funds.
Certified business valuators use comparable sales data (if available) and a variety of mathematical techniques (coupled with some assumptions) to value a company. In the current market, these types of valuations tend to be conservative but consistent between valuators. They are particularly useful for estate planning, divorces, and in instances where there is more than one shareholder in a company.
Analysis of comparable sales is one part of any valuation. The “comp” data is typically provided to valuation databases by M&A advisors. Analysis of a recent list of comps used in a formal valuation, showed that of 36 comps listed, only seven were in the revenue range and only one was actually a comparable company. Accordingly, “comps” must be considered with a great degree of scruitiny and used only if they pass muster through a due diligence examination.
Those of us in the M&A advisory business use “multiples” of historical earnings to as an aid in determining the value of a company (and its future earnings). The multiple selected is based upon a number of variables including the type of industry, growth history, profitability, dependencies, projections, and value of fixed assets. One must understand that the inverse of a multiple is the expected return of investment. Accordingly, a 3X multiple infers a 33% ROI while a 7X multiple infers a 14% ROI.
While aggressive stock/bond and REIT investments can yield a 15% ROI, these investments have a much lower risk than investing in a company. This is because the investment is liquid and marketable (can be sold within 24 hours), is not dependent upon specific clients or suppliers, and is not dependent on key employees.
Investing in a privately held company is much riskier. It is not a liquid investment as it takes 9–12-months to sell. There is no open market of buyers, and there is a dependency on customers, suppliers, and key employees. Because of these factors, savvy investors in companies expect a high return on investment.
Recent Example: A company involved in value added distribution of relatively expensive products.
Revenues dependent upon a small group of inside sales representatives.
One supplier is a major contributor to revenues.
Revenues have not increased in the previous four years (2018 – 2021).
2021 earnings have improved due to higher gross margins.
There has not been a projection for sustaining higher gross margins or increasing revenues in 2022 and beyond.
A formal business valuation was performed on the company in 2019 with a value of S11,000,000.
Based upon our detailed review, RC Advisory Services estimated the 2022 value to be $14M - $16M (4X – 5X)
A competing M&A firm indicated that they could sell the company for about $23M - $29M. This sales price yields a projected sales multiple of 7.5X which relates to a 13.3% ROI. The prospect selected our competitor but was ultimately unsuccessful in selling the company.
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Question: why would a buyer purchase a company with no recent history of growth and no competitive advantage for 7.5X historical earnings (14% ROI)? While we were disappointed to not get the engagement, RCAS remains committed to never suggesting an inflated selling price in order to gain a client.
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