Sell your business? Global uncertainty

global uncertainty | bizval business valuations

The only certainty is uncertainty. After all, that’s why bankers like to refer to “risk capital” in a business. If we operated in an environment of certainty, then valuations for businesses wouldn’t be necessary. There would be no debate over the correct discount rate in a discounted cash flow valuation, or the shape of the underlying cash flows.

How utterly boring that would be.

Luckily, humans are unpredictable and innovative, which makes markets an uncertain place. We see this every day in listed markets, where buyers and sellers form their own views on company valuations and trade accordingly. Private company valuations are actually just as volatile, but we can’t see it as clearly because the shares aren’t changing hands every day.

For far too many entrepreneurs and founders, price discovery only happens when they start the process of trying to sell a business. At that stage, the impact of global uncertainty on the business valuation becomes far too clear.

Wouldn’t it be helpful to know about these impacts much earlier in the process, allowing for proper planning?

Mark yourself to market

When finance professionals mark-to-market a financial instrument, they are reflecting its value with reference to a listed market. This is because of the price discovery process mentioned above, as trades happen every day and buyers and sellers are coming together to give their views on what the asset is worth.

Private companies don’t do this, of course. That’s exactly what makes them private rather than publicly held. There’s no trade in the shares, unlike in public companies with shareholders who can buy and sell at will. This can lead to vast discrepancies in expectations between the seller (usually the entrepreneur or founder) and potential buyers. Instead of a price that changes in increments every day, sellers take a business to market and often get a shock at the responses, or the terms attached to any potential transaction.

This creates multiple layers of uncertainty. Not only are all the participants in the deal having to form a view on where the world is headed, but they also have to dance around the issue of deal expectations from the other parties. If the business owner is lucky, perhaps there’s a fractional CFO in the business who can assist with these matters, or some kind of advisor. For most entrepreneurs though, no effort has been made to understand the business valuation and how it developed over time.

By essentially “marking yourself to market” by getting a professional business valuation done for your business, you can get an educated view on the how the current global economic climate is impacting your valuation. Of course, you’ll also get plenty of insight into how your margins and growth rates compare to peers and what this means for the valuation multiple that a buyer would likely offer you.

Get on the right side of information asymmetry

We may as well touch on another concept that investment professionals know all about: information asymmetry. This simply refers to a scenario where the parties on either side of the table don’t have the same information about the asset being discussed. In the listed market, investors are supposed to all be operating off the same tapestry of publicly available information in the form of listed company results. In private deals, information asymmetry is a huge thing.

The founder knows the business inside-and-out, whereas the buyer is operating from a place of great uncertainty.

To try and address the uncertainty, the buyer uses various strategies:

  1. Put in a lower offer for the business to leave a margin of safety
  2. Conduct an extensive due diligence on the business
  3. Build in protective terms like profit warranties and earn-outs

Inevitably, all these strategies are used rather than just a few of them.

If the buyer is putting in place steps to address information asymmetry, then shouldn’t the seller do the same?

The seller might know all about the business, but may not be well versed in valuation techniques and how other investors might view the operations. Understanding the difference between financial and strategic buyers helps tremendously in this case, yet far too many founders don’t learn about these concepts before trying to sell. When the earn-out provisions arrive in the offer letter, sellers get an absolute shock as they never considered that payments for the business may be deferred, let alone conditional on profit targets.

The buyer is going to work hard to reduce information asymmetry. It’s a wonderful way to manage uncertainty in the deal process. As the seller, you really should do the same.

At bizval, we can easily assist you with taking three steps that could make all the difference:

  1. Get a business valuation long before you are planning to sell
  2. Identify the weaknesses in the business that a buyer will use to negotiate a lower price or include more onerous deal terms
  3. Understand the key financial drivers of the valuation and how they can change over time, including business-specific and macroeconomic factors

Don’t be a victim of information asymmetry and uncertainty. Contact us to discuss how best we can assist you through a combination of our concierge and bootcamp offerings.