Reading The Tea Leaves On Business Valuations In 2023

2023 m&a update exit planning increasing business value preparedness planning Jan 27, 2023

Sale Activity Slowed In 2022

The U.S. small business M&A market showed a slowdown in 2022. With an activity decline of nearly 50% in the number of completed transactions for businesses under $100 million in value, it is a clear indication that the concerns of the U.S economy has had an impact on buyers’ willingness to transact in 2022. There were 945 transactions totaling $24.3 billion down from $48.1 billion in 2021 making 2022 the lowest year in transaction activity since 2009.

In 2022, the average business value was $15.6 million which would continue to demonstrate that financial buyers are still busy adding on to platforms and performing tuck ins. This is important to smaller businesses as it demonstrates plenty of activity in the lower tier of the small business M&A market.

A key indicator from 2022 that business owners should pay close attention to is the decrease in EBITDA multiples from 2020 to 2022. Multiples have slipped from the high of 8.5x in 2020 to 7.4x in 2022 (a full 1x loss in multiple). It is difficult to predict if markets will see a return to higher multiple levels as 8.5x was the highest multiple average for small businesses in the past sixteen years.

 

What does this mean for business owners that are thinking about selling or want to prepare for a transition in the coming years?

 

Three Steps to Increasing Value

Step 1: Have an assessment conducted to see if the value of your business is suitable and meets your expectations:

With the current economic challenges of the current market environment, it is important to understand how the value of your business translates in the current market. It is also important to understand the changing trends of a transaction. Some of the changes may include:

  • less of a willingness by buyers to normalize financials from the pandemic years and more focus on the recovery of the business
  • less debt used in a transaction causing more stringent transaction terms
  • how buyers perceive and manage the risk of owning your business in this current environment

It can be frustrating to start a transaction process only to learn that your lack of preparedness has caused the difference in market value and emotional value to widen. It can be extremely frustrating to find out during your sale process that the main reason your transaction failed is the lack of preparedness. You can avoid this pitfall by being prepared.

 

A business assessment can save hundred of thousands of dollars in wasted service and advisor fees.

 

The benefits of having a formal assessment completed are:

  • Saves you time and resources on a failed outcome.
  • Gaining an understanding of the current value of your business.
  • Enables you to make an educated decision about when or if you should sell.
  • Provides an action plan for increasing enterprise value.

 

Step 2: Educate yourself on the sale process:

The process of selling a business can be a very stressful situation as a business owner. Especially, if you are not prepared, don’t have the right team, and are not up to speed on what is needed to have a successful transition of the business. Here is what you need to know about the sale process:

  • Minimum three years of financials: In most cases, buyers will want to see a minimum of three years of financials: Balance Sheet, Income Statement, Profit/Loss, and Owner’s Emoluments (Potential add-back expenses). If you are being creative with the financial reporting or managing your P/L to minimize tax liabilities, you should keep in mind, if you plan on selling at some point in the future, that strategy can cost you value when you sell.
  • Cash to accrual accounting: If you are currently on a cash accounting basis, it is ok. Most smaller businesses use cash basis accounting. If you are thinking about selling, you should speak with your accountant about implementing accrual-based accounting. It is important in helping to substantiate the health and accuracy of earnings.
  • Know your company's earnings before interest, taxes, depreciation, and amortization (EBITDA): In most cases a business will sell for a multiple of EBITDA or multiple of revenue. Businesses that sell for a multiple of EBITDA have historically sold for 4-6x EBITDA. So, if your company has $20 million in revenue and $2million in EBITDA, the historical market value for your business would be $8 million to $12 million. There are many reasons why you would receive the high or low range of market value. One key factor is being prepared and having a well-managed business, with a good management team, sounds operations, financial transparency, and updated documentation. Other areas that can impact your value range is: the industry your in, buyer activity in your industry, and trend of your EBITDA over the past 3-5 years. Is your EBITDA trending up or down over the previous three-year period? If trending downward, it will have a negative impact on business value.

 

Step 3: Create your 2023 Growth Plan:

Whether you’re selling in 2023 or thinking about selling in the future, it is important to have a well thought out  growth plan. When you do engage buyers, they want to understand your vision for growth. It is a key factor in evaluating the potential of your business verses a competing company a buyer may be interested in. Another key point is you want the make up of your business value to consist of past revenue performance and future growth potential. If you don’t clearly lay out your company’s growth potential to a buyer, you're leaving it to them to make assumptions about the future growth of your company. In this scenario, you are probably losing value.

The Benefits of Growth Planning:

  • Helps you and your management team focus on key initiatives of the business.
  • Provides goals and milestones to manage towards throughout the year.
  • Helps identify potential issues or challenges you can address and overcome through planning.
  • Demonstrates to a potential buyer your commitment to growth.

 

What are five key initiatives you should focus on for 2023:

  1. Revenue
  2. Expenses
  3. Marketing
  4. Operations
  5. Branding

Why are these five initiatives so important to your growth planning strategy?

All aspects of your business fall under these five initiatives and formulating and prioritizing three goals for these five initiatives creates an executive summary that can be incorporated into a formal business plan, action plan or strategic “go to market” strategy.  

Remember: It takes money to sell your business

Imagine a scenario where you have worked hard to build a successful business and now it is time to cash in and unlock the illiquid wealth you’ve created but you don’t want to invest in the appropriate resources. This scenario alone, losses millions in enterprise value for business owners every year. Budget a minimum of 5-7% of the value of your business towards your preparedness and advice budget. However, If your go through the sales process and are unsuccessful, you can pay nearly 10% .The total of the failed and completed transaction. Another key reason why business owners should always be prepared.

For more information, click on the link below or contact me on LinkedIn to build your transition budget.

Final Point:

There is always a market for good companies. Good companies will always demand maximum value. You should prepare for your transition, so no matter when your time comes to sell, your business is a well sought after asset that is well positioned regardless of market conditions.

 

Written by: Brett Dearing, CEPA®, CM&AA®

Host of the The Exit Podcast

 

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