It’s easy to get wrapped up in the day-to-day operations of your business.  It’s also imperative that you take a step back now and again and take an informed and critical view of what your business might look like to someone from the outside.  What would you do that for?

The decisions you make will eventually impact the valuation of your business one way or another.  Consider how you make decisions around the following strategic areas . . .

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You know everything about your business or so every business owner assumes.  Many experience a rude awakening, however, when they attempt to sell or recapitalize their business and the buyer begins the due diligence process.  The bad news is that you can't avoid the due diligence process if you ever intend to sell or recapitlize your business.  However, you can predict how buyers will generally approach the process of due diligence and prepare for it.  Here are things that are important to all buyers we've ever encountered and questions that you will be asked:

1. How much cash does the company generate? Buyers want to know how much free cash flow your business generates. They’ll want a reasonable salary for the business’s CEO, as well as enough additional free cash flow to pay for the business over five to seven years.
   
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It's generally hard to find good financial data about small business.  It's even harder to find good data about small business merger and acquisitions trends.  What we try to do for the CFP Blog is find articles about trends impacting larger businesses yet mirror what we're seeing for small business.  We came across this article in Business Week that gives us some insights as to what we believe 2010 has in store for small business M&A.

In a nutshell, we expect small business M&A to go sideways for most of 2010.  Some deals will get done but for the most part, buyers and sellers will have to reconcile some differences before we return to more normal deal activity.

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A lot has been written and said about the tightness in the credit markets that many small businesses across the country are experiencing.  But we've wondered how the credit markets are affecting small business deals.  More specfically read this post as "what do I need to think about if I sell or recapitalize my business in the next 6 - 14 months."

We came across an excellent article describing what is happening in deals that are currently getting done.  Needless to say, we found article the from the TheFreeLibrary.com very interesting.

The first thing to keep in mind is that deal volume is down significantly:

In the twelve months ended July 31, 2009, the aggregate volume of U.S. public M&A fell 61% from the same period in 2007, to approximately $432.5 billion, with private equity activity declining 98%, to $10.7 billion. Pending transactions were tested by financing failures, underperformance and litigation, and negotiating parties were forced to reconsider transaction terms in the context of general economic uncertainty.

The last sentence is telling and sets the tone for the rest of the article.

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Different buyers have different objectives and levels of experience. Understanding these differences can help you in getting the kind of deal you want. As you begin discussions with potential buyers, it's important to keep in mind that buyer’s goals and objectives vary greatly. In general, buyers can be classified into three groups:

• strategic buyers (public and private industry competitors) 
• private equity groups
• individual or “angel” investors

The valuation you get for your company will vary based on the type of buyer:

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What are the key value drivers when preparing your business for sale?  Several inter-related factors help determine the salability and value of a privately held business. A successful business sale depends on attention to each factor.

Financials
Ultimately, a business sale is usually structured based upon a multiple of cash flow (either EBITDA or Discretionary Cash Flow). To facilitate a business sale, an owner must have all of the financial records segregated and in good order. At a minimum, buyers are interested in reviewing three years of historical financial statements and tax returns. Differences between taxable income and book income (e.g. cash basis vs. accrual) should be identified and explained. Identifying, explaining and eliminating significant discretionary expenditures along with unusual and non-recurring expenditures and losses also are important.

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As the old saying goes, three things drive value in real estate: location, location, location.  While that saying can provide an inkling of the value of the real estate your business owns, what drives the value of the business itself?

Small Business Valuation Drivers

Regardless of who you look to for statistics, the fact of the matter is small business is the heart of the American economy.  Consider numbers like small business:

• Represents more than 99.7% of all employers
• Create about ¾ of the net new jobs in the US
• Employ almost 62% of the workforce
• And account for more the 60% of the gross domestic product of the US.

Despite these impressive statistics, the valuation of small businesses isn’t a science.  Buyers and investors will look at an opportunity through the glasses that represent their experience with similar businesses.  If they’ve been successful with or know someone who was successful with a similar business in the past, valuations will be more favorable.  If they’re unfamiliar with the business, valuations will reflect their perceived increased ‘risk”.  But how will the value of your business determined?

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Are historical financial metrics the exclusive drivers of your company’s value?

Yes, if they’re all you can prove to potential investors or buyers.  But what else can you show them that would potentially drive up your company’s valuation?

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