Selling a Closely-held Business

Selling your closely-held business can be a very trying and emotional undertaking. The years you have devoted to growing and nurturing your company is a very personal matter. But these sentiments could cloud your ability to determine an asking price that approximates what the market can bear.

Engaging a certified business valuation analyst as a consultant can help you arrive at the best deal for you under the circumstances. Usually an analyst is retained to provide an independent opinion as to the fair market value of a closely-held company, but in this case, the valuator will be working with you to arrive at a price to start negotiations, as well as the financial terms of the transaction. The analyst will be part of the team that includes your corporate lawyer, to help you achieve a successful deal.

It is important to know before arriving at any asking price that any potential buyer is buying the anticipated benefits your company can generate. Historical results may be a path to project those benefits, but the main focus is prospective or forward-looking.

The following approaches are ones that the analyst will consider on your behalf.

Asset Approach

The asset approach establishes value by netting the market value of the company’s assets by its liabilities to determine the net asset value, or net worth of the business. This approach is usually effective when valuing companies that are marginally profitable, or have no earnings history because it omits intangible assets such as goodwill. Goodwill has no physical existence, but is the result of earnings generated associated with a business’s name, reputation, customer loyalty, location, products, and similar factors.

Market Approach

The market approach calculates the value of a business by comparing the company to similar businesses that have been sold. Depending upon the size of the business and other pertinent factors, generally, this can be accomplished by a comparison to publicly-traded companies, or by an analysis of actual transactions of similar closely-held businesses.

Ideal guideline companies should be in the same business as yours. However, if there is insufficient transaction evidence, it may be appropriate to consider companies with an underlying similarity of relevant investment characteristics, such as markets, products, growth, cyclical variability, and other salient factors.

From the group of companies selected for their ability to provide valuation guidelines, a ratio is developed, such as the price/revenue ratio, with which to capitalize the base.

The problem with this approach is that it does not take into account reasons the businesses were sold or purchased. Specific situations, such as a seller who felt compelled to sell quickly due to illness, or buyer who was interested in removing a competitor from the market, can understate or overstate the sales price.

Income Approach

The income approach equates a business’s value with its future earning capacity. Many valuation experts tend to place more emphasis on this method, though they’ll factor the other approaches into their analyses as well.

The future earning capacity can be based on a variety of factors such as earnings before interest, taxes, depreciation and amortization (“EBITDA”), or net cash flow available to the owners. The choice will depend on the specific business.

Regardless, the earnings number should be adjusted accordingly to present the operations of the business the buyer might expect as a return for any investment. Adjustments may include the removal of certain discretionary expenses, such as excess owner’s compensation or benefits, and related party transactions that are not arm’s length. If not provided for, these amounts tend to distort the value of the business.

Any projections used to determine the value will need to be supported by reasonable assumptions.

The appropriate multiplier to apply to the earnings will depend on many factors, such as the:

  • Risks specific to the industry and your company that would prevent the projected earnings from materializing
  • Competition
  • Location
  • Reputation of the business
  • Strength of workforce

The Bottom Line

The approaches outlined in this article can act as a starting point when determining value. But, oftentimes, the valuation process will incorporate multiple approaches — though one may be given more weight than others.

Business owners can set the groundwork for an effective valuation by keeping solid financial records, operating their businesses at optimal capacity, and gaining an understanding of the various methods involved.

Above all, engage a certified business valuation analyst. He or she can bring a solid understanding of these approaches and the sale of businesses. But, just as important, a valuation professional will be a disinterested party who can objectively assess your business. As a result, he or she can reach a credible, defendable value estimate.

Sidebar: Five Things to Keep in Mind When Selling Your Closely-held Business

Here are five things to keep in mind when selling your closely-held business:

  1. Stock Sale vs. Asset Sale. If your company is incorporated and you sell your shares of stock, your gain, if any, will be subject to capital gains tax rates, usually a lower rate than ordinary income tax rates. Note, that this does not take into consideration alternate minimum tax. In an asset sale, the company is subject to income taxes.
  2. C Corporations vs. Pass-through Entities. The type of entity your company is will affect how you are taxed in the sale of your business. If your company is a C corporation, this may result in double taxation, because any efforts to distribute the profits after corporate tax can result in individual income taxes as well. If you are a pass-through entity, such as an S corporation or limited liability company, then the gain will generally “pass-through” to you and you will be responsible for the taxes. Therefore, when negotiating the final sales price, you need to understand the effect the entity type will have on the net proceeds received from the transaction.
  3. Undetected Claims. Undetected claims of your company may not be settled until after the company has been sold. These claims generally will remain with the business, but you should consult your legal counsel on the most productive ways to shield you from these liabilities, before any negotiations get underway.
  4. Non-compete Agreements. The buyer may request you to sign a non-compete agreement as part of the transaction. Legal counsel can advise you when determining if the provisions are too onerous and unreasonable under the circumstances. It should be noted that any compensation received under such agreement will be ordinary income to you.
  5. Organize Your Records. Financial statements in compliance with generally accepted accounting principles can help boost potential buyers’ confidence in a business. Depending upon the size of your company, it may be time to consider having the company’s financial statements audited or reviewed by an independent certified public accountant.