Setting Expectations before you Sell

Every CEO has expectations for his business. Throughout many years spent building, managing and growing his company, an owner likely has forecasts and predictions around every aspect of the business – production output, headcount, sales levels, customer growth, revenue – the list goes on. When it comes to putting a company up for sale, however, CEOs often do not know how to calibrate their expectations around the price they will receive or the process they can run.

Without the tools to properly come to reason around the projected outcome of such a transaction and because a CEO has likely poured his heart and soul into his company, sellers often enter into a deal with unwieldy and unrealistic expectations. In fact, studies have shown that 70% of deal professionals find seller expectations the most difficult aspect to manage when doing a deal and that it’s the reason most deals take years to close.

For a CEO thinking of bringing his company to market, there are three areas to begin to understand about the surrounding M&A environment and the way buyers will evaluate their targets. By starting with an exercise based in logic and research, a CEO can better enter negotiations with a realistic number, timeframe and outcome in mind.

Market Environment

A recent study found that 40 percent of baby boomer business owners will look to sell their businesses by 2022. Particularly in an environment where so many businesses are coming to market, CEOs should examine the number of opportunities in their segment before pricing their own sale. Scott Bushkie, President of Cornerstone Business Services, noted in a recent Forbes article that “it’s unlikely values will increase as long as there’s a larger number of baby boomers selling than there are buyers looking for [opportunities.]”

Business owners should be cognizant that in a saturated market where a buyer has the luxury of choice, their selling power can be significantly reduced, regardless of how profitable the business has been.

Before preparing his company for sale, a CEO should research his competitors to gain a greater understanding of their position in the same market segment. This information can be helpful in evaluating their own company’s value creators, such as their customer list, intellectual capital or property, growth margins and barriers to entry. Ultimately, this will help owners assess their market value and be able to articulate how they stack up to comparable businesses.

Scalability and “Risk Factor”

Particularly if a CEO is thinking of selling to a financial buyer who will eventually have to realize a return to his investors by selling the company or taking it public, the scalability and risk profile of the business matters.

Assessing one’s business in these two specific areas is a vital exercise before entering into any deal negotiations. Companies that have successfully diversified across product lines, geographies and customer segments may have an easier time proving scalability to a would-be buyer.

On the other hand, businesses that have grown quickly, recently entered new markets or geographies should properly run a risk assessment on their business before going to market and understand how buyers may bake in certain factors as they price the deal. It is often said that with risk comes reward, but it is important a seller calibrates how a buyer might perceive the value of a risky business model in the context of his goals for the deal.

If a CEO comes to recognize that his business has potential for scale or that there are pieces that leave it at a serious degree of risk, putting off the sale to focus on some internal changes is not a bad strategy. In fact, many companies are using rich corporate balance sheets to scoop up complementary companies or competitors to build upon their market position before entering into a sale process.

Company Valuation

Many sellers assign their companies a multiple without much thought behind it. Maybe they look at what average multiples in their sector are, based on public company information or perhaps a competitor who sold last year disclosed the details of the deal. Particularly in an environment where there has been some multiple inflation, it’s important to get behind how such a multiple is applied and that starts with understanding how private companies are valued.

There are many ways to value a private company and every buyer may use a different method. One of the most popular, however, is Discounted Cash Flow analysis. The Discounted Cash Flow (DCF) business valuation model is grounded in a simple concept: the value of any given business is equal to the sum of all future cash flows of that business, discounted to reflect their value today.

Without the tools to conduct such analysis, a CEO may be tempted to look at companies in his same industry that have sold recently and assign the same price (or a higher one) to his own sale. It’s important to remember, however, that not only is every company different, but every buyer is too. Each individual buyer and seller has unique motivations and a deal gets priced accordingly. The best course of action is to engage with a banker or advisor who can give some insight into the unique situations behind such deals and help a CEO understand why and how their valuation may be come to in a different way.

Seeing it through the buyer’s eyes

At the end of the day, the best way to set realistic expectations for a sale is by realizing that price is ultimately set by what a buyer is willing to pay. It goes without saying that a CEO considering such a transaction should be intimately familiar with the business’ financials, but in approaching a sale he should focus extra attention on the metrics a would be buyer will evaluate.

There is danger in relying solely on public market multiples, past transactions, or “best guess work.” In order to set reasonable expectations, an owner truly has to see his business through the eyes of the buyer and understand where it fits in the overall M&A landscape, the potential it yields for the buyer and the valuation that can be assigned at the time of sale.

Hiring a skilled advisor can help keep expectations level when entering into the sale process. Not only will this individual lead the company through the necessary valuation exercises, evaluate the competition and suggest ways a company might add value before going to sale, but he will also help jumpstart the next most important phase of the process – building a list of potential buyers.