There are many reasons for declining values of small, privately held companies. On this edition of “Deal Talk,” we’ll talk with Russell Glazer, CPA and partner at Gettry Marcus in New York, about some of the most common ones, and why you should think twice before attempting any “quick fixes” to improve the value of your business. We’ll discuss smarter alternatives to those quick fixes, as well as how often you should have your business appraised, and the best approach to setting a value for your company.
One thing the seller has to keep in mind is having a realistic expectation of the value of the business.
- Russell T. Glazer
Jeff: Before we get started Russ I'd like to just take a moment. Give us a brief but wide angled view or description of Gettry Marcus, what your company is all about and who you serve?
Russell: Sure. We're an 85 person CPA firm in the New York metro area. We've been named for several years now among the top 200 firms by IPA publication. Full service accounting firm; we do audit, tax, a lot of consulting work. We have specialty areas. We work in the real estate area. We have a health care group that does a lot of consulting work for medical practices. And I work in the group where we do business valuations and forensic accounting work.
Jeff: Russ, it sounds like your firm really is a full-service firm that really can be a one stop type of company for any number of needs that a business owner might have. And I think it's fair to say also too based on our conversations before that we had before the program that you help companies of all sizes and all industries. Is that right?
Russ: Yes, that's right. Speaking on the valuation side which is my specialty area, the kind of businesses that we do valuation work for are all kinds of industries, wholesale, retail, manufacturing. I've done valuations of companies that are in their start-up phase and haven't yet sold a single product, they just had a prototype. As well as companies with $700 million in revenue that were well-established including one recent case where they're actually in the, believe it or not, 11th generation. I've been a CPA for over, it's hard to say, but over 35 years now. And I've been doing valuation work since the mid 90s. Although it was part of my CPA practice so it wasn’t a full-time thing for me. Probably half of my time is spent in valuations up until 2008 when I joined Gettry Marcus. And one of the reasons I joined Gettry Marcus is because we have a very active, thriving valuation practice where I was able to offload my CPA work to my partners and dedicate myself just to valuation work as well. Over the years I've written 10 or 12 articles that have appeared in peer reviewed publications on valuation topics. And made presentations around the country. It's really as I hope you can tell a subject that I really love talking about and doing. I consider myself very fortunate.
I joined Gettry Marcus because we have a very active, thriving valuation practice where I was able to offload my CPA work to my partners and dedicate myself just to valuation work as well.
Jeff: Russ, again, thank you so much for being with us. We're going to talk about some things that may be of interest for the first time to some small business owners who might be listening to Deal Talk today. It may also be perhaps a refresher for some of our other listeners. But let's go ahead and get right into it. You have been around a while and you had a chance to work with so many companies in your line of work, in your industry, across a broad spectrum of industries I should say. Every company is different, but at the same time it seems that there are certain causes that really kind of tend to stand out that many companies have in common with each other. For declining or less than optimal valuations on their end, what are some of the most common but correctable causes for declining values that you have seen in your career?
Russell: Certainly there are a lot of factors that are not in the business owner's control that can't be overcome necessarily. But valuation really comes down to two things. Any financial asset valuation comes down to two things, which is return measured by cash, and the risk of achieving that return. So the valuation of any business is very, very closely tied to the amount of cash flow it generates and the riskiness of achieving those cash flows. So the things that are within the business owner’s capability to modify as far as cash flow is concerned or efficiencies of operation, profitability, pricing the product properly maximizing the operational aspect. But from the business standpoint what a lot of business owners don't see, they're unable to visualize is risk can be present in a lot of different ways. With small businesses that kind of risk is often in the form of lack of depth of management where there's an autocratic owner that hasn't really begun to pass responsibility on to his or her managers, his or her next level of operational team. And when a potential buyer sees that, they see a company that may be difficult to step into without a lot of disruption. I've seen a number of cases where an autocratic owner that was suddenly through health issues or other problems suddenly unable to have the services that person and that kind of company goes through very, very difficult and sometimes very lengthy period of disruption before they can get back on their feet again. Risk can also be measured in terms of competition for a similar product. There's nothing that differentiates your product or service that it's easily challenged by competitors, and that's also a significant risk. Other risks are having reliance on a particular customer, particular vendor, or even within a certain industry. So if a company sells most of its products, to let's say the automotive industry and has not been able to adapt to sell those products or other industries that may not be subject of the same vagaries of the automotive industry, that's another element of risk. These things are areas that the business owner can affect, although many of them as you can imagine take a lot of time and planning in order to improve but it can be done.
Jeff: Really, what you're doing as an owner really, and you talked about it a second ago, really through no fault of his or her own could be leaving a lot of money on the table because they're paying too much attention to perhaps this segment of the marketplace or this particular client or groups of clients without really taking time to broaden their perspective. And part of that really is because owners, many of them never really seem to get over this it seems to me, Russ, are spending so much time working in their business as opposed to on their business, isn't that true?
Russell: Yeah, that's a very good point and it's a very easy trap to fall into, to be very involved in the day-to-day operations and not step back and see the business as an outsider would, again, with risk and return as the primary focal point so you're exactly right.
Any financial asset valuation comes down to two things, which is return measured by cash, and the risk of achieving that return.
Jeff: We're going to talk about some other things that might be of interest to our listeners today Russ, including the types of sales that are out there. We're going to that a little bit later in the show. But I'd like to get back to the idea of how to fix things. And if I'm a business owner and I come to you and I'll say, “Russ Glazer, I really want to sell my business. I'd like to get out ideally in maybe three or five years.”You've come back to me with all of these things that you've uncovered in your research and providing me with your valuation, the appraisal of my company. What can I do quickly to fix some of these things so that I can have you come back and then reappraise my company, and so I can list it maybe in the shorter rather than the longer term. Have you had any examples of companies that you've worked with who came to you with that question? They had these issues, they wanted to fix, they wanted to address, they wanted to get them taken care of right away and see all of a sudden these amazing improvements to their value and get out as quickly as they possibly could?
Russell: We’ve seen situations like that. The problem is that it's very difficult to affect a quick change, and even if you can a savvy buyer would much rather see a longer track record that he can hang his hat on of reliable high returns, or reliable high efficiency, whatever the case may be. That minimizes their own due diligence work. Buyers spend an awful amount of time and energy on due diligence efforts. And if they see a quick fix they'll look at almost everything with a skeptical eye because they know the company's being, I would called it a window dress that's actually for sale as oppose to being a solid track record of company improvement. Companies go through ups and downs all the time of course, but a quick fix ... Several examples might be letting some staff go to reduce payroll costs but of course the buyer, if they do the due diligence will recognize that they have to replace these people so they’re going to be very skeptical about the short term results. Another area where a company sometimes tried to window dress is in delaying the acquisition of fixed assets, capital improvements and replacing the fixed assets. They may let those assets deteriorate to the point where they're barely able to run on chewing gum and duct tape. They improve cash flow on the short-term but again, a buyer doing his or her due diligence will recognize that not a lot of money is going into improving the infrastructure of the company, and would see through that. A company can take steps for a quick fix but if there's any real significance to the transaction where the buyer's going to do proper due diligence that will probably get smoked out pretty soon.
Jeff: I think Russell Glazer, wouldn't you say that business sellers, owners who are looking forward to getting out and selling their business may not give enough credit to those buyers out there for being as savvy as they actually are.
Russell: Yeah. Sometimes they think they can, I wouldn't say fast talk necessarily the buyer, but put out some explanations that may not carry the day once they begin to be scrutinized.
Buyers spend an awful amount of time and energy on due diligence efforts. And if they see a quick fix they'll look at almost everything with a skeptical eye because they know the company's being
Jeff: Would you suggest that loosening up credit policies to maximize revenue before I sell my business, would that be one of those quick fix types of things that you would not recommend?
Russell: That would be an example, unless of course the credit policy has been overly strict over time and has scared away, let's say some potential customers. If the credit policy was too restrictive and it's loosened to something that's more common in the industry that could be a beneficial maneuver. Again, it would take time for that to play out into a lengthy track record, but that's something that could be explained to the buyer, and the buyer would have to make their own assessment as to whether that's going to generate X dollars more revenue or not. But if it's already a fairly common credit practice that's now being loosened beyond caution just to window dress, then that will come out in the wash as well.
Jeff: How soon should a company, whether they're interested in selling or not, how soon should they have their first business valuation or appraisal?
Russell: It depends because there are a number of reasons to have an appraisal other than an ultimate sale of the entire business. If a business owner has other partners or shareholders in the business that are older that might be looking to retire soon, or that are younger, that might want a higher percentage of ownership. But there's key managers that may want to be invested in the business to either give to or share sales to. Those are a number of reasons that a valuation will be very, very useful long before there's any contemplation of actually selling the business. Certainly estate or gift tax planning of any of the owners would be another example of situations where a valuation would be very important or critical even though a sale of the business is not on the horizon at all.
Those are a number of reasons that a valuation will be very, very useful long before there's any contemplation of actually selling the business
Jeff: What about for tax planning purposes and also to domestic types of reasons, for example, if there's a divorce of one of the owners or the owner of a company?
Russell: That's a great example, which is why not so much for divorce situations, although it can be helpful there but more so where there's multiple owners with differing objectives in terms of their age, or their particular wealth status. Let's say one owner has other sources of income and isn't as reliant on the business in question for their income. Where there’s differing objectives it may be wise to have a valuation done periodically so that the parties know in advance if I choose to retire, if I want to try to buy my partner out, if all of a sudden my health deteriorates, rather than it being a mystery what that person's percentage of interest might be worth, it's a figure that's known pretty closely from year to year so the parties can plan better, they can have the proper amount of insurance to cover a death, for example, in a cross purchase type of buy-sell agreement. So again, there's a whole host of reasons why knowing, I wouldn't say in real-time but certainly within a year or so of the last valuation, what the company's worth would be very valuable to measure.
Jeff: We're talking about valuation and giving you some things to think about before listing your business for sale, with our guest Russell T. Glazer, partner with Gettry Marcus CPA, P.C. My name is Jeff Allen, you're listening to Deal Talk and we'll be back in 60 seconds.
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Jeff: Welcome back to Deal Talk, I'm Jeff Allen with my guest Russell T. Glazer, a New York-based CPA with the firm Gettry Marcus CPA, P.C. in New York. Let's jump over to the types of sales that there are out there Russ. I think that sometimes people don't really give much thought to this, and particularly if they're not really interested in selling their business right away. But sometimes different life events during the course of a business may necessitate a change in mindset with respect to the kind of sale that a business needs. I was hoping that maybe we'd go through some of these types of sales, know which type of sale, and how to know which type of sale might be most financially advantageous to a business.
Russell: Sure. There are two types of sales. There's an asset sale and a stock sale. In an asset sale the acquiring company purchases just certain assets of the company. Typically it's the productive assets meaning any machine and equipment, good will, customer list, things of that nature that are needed to operate the business from day-to-day. Typically in an asset sale the seller retains -- we have the cash at the transaction date. It's the seller's responsibility to collect the receivables and to pay the trade payables. So the buyer's only acquiring certain assets, and the buyer of course has to put in working capital to replace the cash receivables and the payables that the seller is retaining. The most significant aspect of that is that in that case the seller, since you're selling the assets, retains the stock ownership of the business corporation, or an interest in the partnership, or single member LLC as the case may be. The seller is still the owner of that entity, which means if there's any pending lawsuits, or a lawsuit that's not even on the horizon yet, for a hazardous waste issue, or a slip and fall issue, or an employee wrongful termination, any sort of legal issue that connects to the ownership of the company. So the seller is selling the assets but retaining that risk. And that's why that's often a desirable way for the buyer to go because the buyer doesn't want responsibility for those types of issues that may have happened years earlier, for which they have no recourse that they own the stock. For that reason the seller would rather sell the stock typically, obviously also in that case the buyer buys the shares of the corporation which includes every single asset and every single liability on the books at the time of the transaction. In terms of, you phrase your question in terms of when would the parties want a particular type: there's other factors that come into play. One of which is the tax aspect of these transactions. And depending on the nature of it the sale of certain assets would be taxed as capital gain. The sale of other assets may be taxed as ordinary income. So there's a whole range of considerations to be made and usually winds up being the result of a negotiation because there's often competing objectives. The buyer wants certain assets that they could depreciate over time. Or they may want certain assets that they can write off right away depending on their own financial situation. Whereas what the buyer wants may cause the seller to pay more tax than they wish to as ordinary gain instead of capital gain. So it becomes a pull and a push to negotiate what the final numbers are. So what the particular parties want is nice going in but as a practical matter winds up being some negotiated middle ground.
So there's a whole range of considerations to be made and usually winds up being the result of a negotiation because there's often competing objectives
Jeff: Does knowing the type of sale of businesses interested in, does that help determine the methodology you use in appraising the business or is it generally speaking the other way around?
Russell: The methodology I would use would be to value the business and how the deal is put together is a separate thing. So the methodologies that we use generally fall into, there's three approaches to value but for an operating company, one that's expected to continue with the long term, it’s not in liquidation or anything of that nature, generally speaking in that situation the asset approach which is the value of individual hard assets would be much less relevant because the company is expected to continue going forward. So the two approaches that remain are the income approach, which is basically computing the present value today of future cash flows that the company is going to generate. Again, cash is king so it's very cash flow oriented. And that's where the risk as we discussed earlier, the risk of achieving those cash flows comes into play in terms of what discount rate to use in order to present value those cash flows. So that's the income approach. Under the market approach the value is estimated by reference to other similar assets that have sold for certain prices. So if we had a company that was a manufacturer, these databases do exist, then we can find transactions of other manufacturers of the same type of product that sold for let's say 30 percent of revenues, or two times EBITDA. EBITDA is a measure of cash flow. Then with certain adjustments to adjust the comparable company, the subject company to these transactions that a pricing multiple is derived and a value for the subject company would be estimated based on those pricing multiples. So the procedures that we go through and the data that we use would be the same regardless of the ultimate type of transaction.
Jeff: With all of that said, and keep in mind, we're just simply for the purpose of this discussion, we're talking predominantly numbers. How will I know when my business is really ready for sale, Russ? Because I've told you, I'm interested in selling my business three - five years out. Is there going to be a certain level of confidence that I'm going to have after you or another appraiser has visited me where he's going to be able to say, "I think we've done as much as we can do here, or there's a lot more you can do before we go ahead and list this thing before we go ahead and turn it around."
Russell: Again, it depends. You want to have, as I said before, an adequate track record. You want to be able to supply the due diligence and be able to answer the questions that come up. We're involved in a situation now where a company had not planned to sell but was approached about a year or so ago, and actually said no thank you, but I guess the offer's got a little bit sweeter. And now we’re in the process of supporting the seller to put the best foot forward for the due diligence effort that the buyer's putting together. And in this case the subject company's books and records aren't the best. Without going to any great detail, some of the very key numbers aren't quite as repeatable, let's say. They aren't as supportable as the buyer's due diligence team would like. So we're trying to interface with those two efforts to explain the circumstances to let's say back into supporting numbers that the buyer can feel comfortable with. It's hard to say when it's ready necessarily if the buyer believes that there's still improvements to be made in either increasing return or reducing risk that maybe it's not ready yet. But other things as you say, other likely events such as health issues and matrimonial issues may force the person's hand. But one thing I want to point out as well is that one thing the seller has to keep in mind is having a realistic expectation of the value of the business. We've seen a number of situations where because the business owner has created his business from a small operation in their garage and has missed every child’s little league game, and dance recital, but somehow the business is worth much, much more than can be justified by the present value of future cash flows. Those expectations have to be managed so that the seller has realistic expectation of what sort of offers are realistic and not just reject offers out of hand that seem too low. The seller has to understand that the buyer is looking at this through the prism of what's the present value of future cash flows, nothing more, nothing less.
The seller has to understand that the buyer is looking at this through the prism of what's the present value of future cash flows, nothing more, nothing less.
Jeff: Russ Glazer, as we close things down on this edition of Deal Talk, final thoughts, i.e. take-aways from our discussion today, recommendations for business owners who are looking to improve the valuations of their companies. Just really quickly, any quick bullets that you can provide?
Russell: I think by and large, I think long-term companies that they understate revenues let's say, or run a lot of personal perks, expenses through the business. There's obviously benefits to that, but we won't go into the propriety of it. But there's all these benefits to that until it comes time to sell because now the buyer, you got to tell the buyer, "I paid for my kids' college education through the business, and we take all our vacations through the business. Therefore the profit is higher than the books show.” That's not going to fly very well with the buyer who needs to be convinced that that's the case, number one, and may say, "It's just not worth the due diligence effort I'm going to pay my due diligence team an awful lot of money to try and track down numbers. I'm not even going to bother. Let me go find some other potential target where I have more faith that the numbers I'm being presented with are what I can expect going forward.”
Jeff: If anybody out there listening to this edition of Deal Talk you've stirred an interest and they'd like to get in touch with you for more information, how can they reach you, Russ?
Russell: Gettry Marcus, we're in Long Island as well as New York City. Our phone number’s there are 516-364-3390. My direct extension is 208 and I'll be happy to speak with anybody either with general questions, to a point of course, or for the more serious about valuation of course I welcome that at any time.
I think long-term companies that they understate revenues
Jeff: Russell Glazer, we sure do appreciate all the time that you've given us today. We appreciate the insight and the input, and we hope to have you back on Deal Talk again in the future.
Russell: Thank you so much. I'd be very happy to be there.
Jeff: Thank you so much. That's Russ Glazer, CPA with Gettry Marcus CPA, P.C. in New York. He's been our guest and we appreciate him very much.
Deal Talk has been presented by Morgan & Westfield, the nationwide leader in business sales and appraisals. If you're thinking about selling a business or buying one call Morgan & Westfield at 888-693-7834 or visit morganandwestfield.com. And for more valuable information and insight from our growing list of small business experts make sure to join us again here on Deal Talk. I'm Jeff Allen. Thanks again for listening. We'll talk to you again soon.