Mergers & Acquisitions

Resources: Interviews with Industry Experts

Our goal at Morgan & Westfield is to provide you, our readers, with high quality information and valuable resources to help you navigate through the process of buying or selling your business. In this section, we provide interviews from various professionals somehow involved in the process of buying or selling a business.

Elliott Chester


How to develop a Strategic Plan for Buying or Selling a Business?

Today we interview Business Appraiser and Certified Public Accountant Elliott Chester, who specializes in Business Valuation, Litigation Support and Forensic Accounting. In this interview, he discusses the different factors that come in to play when buying or selling a business, and how those factors can impact a sale. Mr. Chester explains how and why book value , equity value and enterprise value can affect the sale or purchase of a business. Mr. Chester also shares with us some valuable advice about getting to know the buyer of your business.

Key Points from our Conversation

  • Business owners I have encountered normally think the business is worth more than it is.
  • Damages cases, also called lost profits cases, are lawsuits filed by parties who say they suffered an economic loss of some kind because of an action by another party.
  • My advice to buyers and sellers is to make sure you understand the terms of the stockholder’s agreement and any repurchasing clauses.


Tina: What are the top mistakes that sellers make when setting a price for their business?

Elliott: I am more in the business of determining the price of a seller’s company using industry and professional standards than I am a broker advising a seller on the appropriate price to set. Professional standards require that I apply the appropriate measure and premises of value based on the situation at hand.

However, business owners I have encountered normally think the business is worth more than it is. This is likely the result of a long-term endearing relationship with the business and a sense of pride because of it. Although this attachment is not unexpected, it does not consider things such as discounts for lack of marketability or adjustments for liquidity deficiencies.

Tina: What is enterprise value? Is this different than equity value? Do I need to know this if I am selling my business?

Elliott: The short answer is it depends.

Enterprise value, also known as market value of invested capital, is:

Fair Market Value of Equity + Long-term Interest Bearing Debt – Cash and Equivalents.

Equity value, on the other hand, is: fair market value of a company’s equity.

In the case of small businesses, book value is more likely to be the same as equity value. For larger companies, particularly publicly traded ones, book value will not be the same because there is an actively traded market for that company’s shares. Fair market value of equity value will be the total market capitalization (number of shares multiplied by the price of the stock), which fluctuates all the time.

Mathematically these two will be different if there is even one dollar of interest-bearing debt or cash. One does not really have a choice between one or the other when setting a price because not only are these numerically different but they’re also conceptually different.

You can think of enterprise value as the price one would have to pay in order to take over the business today, assuming its debt and all. Equity value is the price you would pay to the owners of the business for their interest in the company. So if you paid the owner enterprise value then you would be paying for the debt twice because you would still be liable to the debtors for the balance owed in long-term debt.

In the business valuation arena we typically do the opposite with debt than that which is calculated in enterprise value. We subtract long-term interest bearing debt when applying the market approach. It is fair to say from a business appraisal standpoint I would side more with equity value as a fair price for the business than enterprise value.

I think business owners need to know this when listing the company because regardless of which method you use (or your broker recommends) the owner will know how to tweak the business to increase the list price and get the maximum value.

Tina: What is book value and does it impact the value of my business?

Elliott: Book value is the value of your assets on paper, net of depreciation. If that does not mean anything to you then do not worry because book value does not really matter for valuation purposes. For small business owners it only matters for tax purposes.

However, some seasoned valuators I have worked with feel strongly that a business cannot be worth less than book value. Those valuators argue if it is, “the business should just close its doors, cash out and sell its assets, and do something more profitable with the money.”

I disagree with this, but only on a personal-needs basis because businesses do more than just carry a high valuation. They provide purpose and security for the owners and those who work for them. However, if I am looking at businesses as an investor and I find one not even worth book value then I get concerned. As an investor I am looking to see which business will be the most likely to provide me a return on my investment. If the business has negative cash flow and is not worth the assets on its books then it’s unlikely I will get my money back, much less a return.

The importance of book value will vary depending on the person analyzing it.

“The saying, ‘beauty is in the eye of the beholder’ is true because the type of person needing a value for your business will dictate the method used to value it.”

Tina: Is there one definitive value for my business, regardless of the purpose of the valuation?

Elliott: You may think there is only one type of person who wants to know the value of your business, but in reality there are more situations which would require a business appraisal. The saying, “beauty is in the eye of the beholder” is true because the type of person needing a value for your business will dictate the method used to value it. No value can be definitive.

For instance, if you are trying to place a value on your business simply to sell it, then you can use rules of thumb or just about any other method. If you are valuing the business for estate or tax purposes then you must use fair market value as set forth in revenue ruling 59-60 in the IRC. If you’re valuing the business because you have filed Chapter 11 Bankruptcy, then you might use liquidation value or fair value , which is different than fair market value. Which value would you use during divorce proceedings if the family business was a divisible asset? What about the value to use in the appraisal of your small business stock plan, such as an Employee Stock Ownership Plan (ESOP) ? Do not forget about sentimental value – the value you secretly think the business is worth – or at least would like to receive.

Value is only definitive when your situation becomes definitive.

Tina: I own a deli and have been in business for 20 years. We are no longer profitable. I am ready to retire, and I am thinking about exiting my business. What are my options?

Elliott: If your business is no longer profitable then it is likely the pool of buyers will be limited. So I would recommend two actions.

  1. Really determine why the business is not profitable. Your CPA can probably help you determine this. If you can figure this out then you can “dress the business up” for a sale by tweaking some things to boost your profitability – reduce staff, change vendors, close certain locations, etc. If you are unable to make the needed changes then you can at least pitch the idea to investors who might be looking for a value purchase; this will mean a reduced price.
  2. If none of those are attainable and you have a substantial amount of assets, then an option would be to sell them all piecemeal. This would be liquidation value and could be close to the proceeds you would receive had you sold the business as an ongoing operation.

Tina: What are damage cases? As a buyer/seller, what do I need to know about this?

Elliott: Damages cases, also called lost profits cases, are lawsuits filed by parties who say they suffered an economic loss of some kind because of an action by another party. This would be important from at least three perspectives.

  1. As a buyer you would want to know if the business had been the recipient of any damages awards or had been a defendant in such a case. Being a recipient of proceeds from a successful damages suit is not bad, but understand how it impacted the financials. If the company has significant revenues in one year, or more years if payments were prorated over time, then it’s possible that some were payments received from the defendant, not from a thriving business.
  2. As a buyer you want to know if the business had been a defendant in a lost profits lawsuit, or if they had to pay any proceeds for being found guilty because that will impact the business going forward. The final ruling could have placed restrictions on the business, banning it from producing certain products, or using specific names or phrases – all on which many businesses depend.
  3. As a seller you want to make full disclosure of any significant past litigation because a buyer could come back to you after the sale, claim his newly acquired business failed because of the outcome of a prior lawsuit, and file a lawsuit of his own. That would not be good.

“A good plan of any kind should always consider the final stages of that plan when charting the initial stages.”

Tina: When should I develop an exit strategy?

Elliott: You should develop an exit strategy when you buy or start a business. A good plan of any kind should always consider the final stages of that plan when charting the initial stages. The businesses I have seen without an exit plan have either lingered in limbo without buyers, or have been litigated. The strategy does not have to be complex or definite for that matter. Getting one down on paper and modifying it as you go is better than nothing at all.

Tina: I am selling my business; will I be responsible for financing the sale?

Elliott: You do not have to be responsible for financing. However, it is very common to see this type of financing arrangement in small business sales because the average buyer does not have the assets to acquire the business or have assets to serve as collateral for a loan.

This is also a matter of personal preference. Some sellers will require buyers to have a loan from a third party. Other sellers who want to get out more quickly will facilitate the transition to another owner by offering to take a portion of revenues or the buyer’s salary as payment. This is seen a lot in professional practices.

From my point of view, seller-financing is more risky for the seller and carries zero risk for the buyer. If the practice fails or the buyer is unable to make payments for whatever reason, there are no real repercussions. The buyer has the downside of no longer becoming the owner, but the hit to the seller is more devastating. The seller has wasted time/years and company money on a sale that is no longer going to happen.

Tina: What is the rationale behind adding back interest and depreciation when recasting earnings?

Elliott: It is a way to get free cash flow, which is the stream of value or benefit stream often used to value a business. Free cash flow is money that a company has to spend as it pleases. Interest is technically a choice by the company to utilize debt to expand or fund capital projects. Depreciation is only a book entry, meaning it is not an outflow of cash. Even though depreciation shows up on the books as an expense and it reduces net income , a company really has the amount of depreciation in cash or equivalents. By adding back both of these items you get to a more true view of profitability. I also add back amortization , as it is not a cash entry either. Some analysts also add back taxes, but my view on the issue is taxes are unavoidable and should not be added back to the value stream.

Other adjustments I make to get to the benefit stream include capital expenditures , repayments of debt, and significant one-time expenses, or revenue for that matter.

“My advice to buyers and sellers is to make sure you understand the terms of the stockholder’s agreement and any repurchasing clauses.”

Tina: Do you have any interesting stories about an appraisal you have done? Maybe something that can help a business owner avoid common pitfalls?

Elliott: I have worked on dissenting shareholder cases, where I had to support or disprove the asserted value of a stock. Often, the shareholder thinks the value was too low and will claim that based on any number of reasons. My role is to come in and provide an independent appraisal that will then be used to issue a decision in court or settle outside of court. My advice to buyers and sellers is to make sure you understand the terms of the stockholder’s agreement and any repurchasing clauses. For instance, if the stock value is computed using a fixed number of factors and is not obligated by law to have an appraisal using fair market value such as ESOPs, then you will not be entitled to an independent appraisal because you agreed to the terms of the valuation.

Tina: How have you seen the business valuation process change over the years? Are things changing for the better or worse?

Elliott: There are at least two trends in business valuation I have noticed in the last couple of years.

  1. As the business valuation landscape continues to grow and mature, new standards are being issued. As a CPA I am obligated to pay attention not only to rules for valuations set by the AICPA, but I also must comply with consulting standards and ethics standards set by the same body. I am also a Certified Valuation Analyst, a credential issued by a separate body with its own standards with which I must also comply. A benefit of hiring an expert with multiple credentials can be a more independent unbiased report, which is often the goal in litigation.
  2. The other trend I have noticed, which is not on process per se, is downward pressure on the prices of valuations. Some internet sites are running valuation-mills, issuing valuations for less than $1,000. You just cannot issue a report that complies with professional standards and do a quality job for that price. A fully billed quality valuation will cost between $5,000-$15000 depending on the nature and complexity of the business. Cheap valuations falsely give business owners confidence in the value of their business, and in some cases cause them to make serious decisions based on that information. Or worse, employees or investors make decisions using those cheap valuations.

“The take-away here is not only to know the expectations of the other party, but also document them.”

Tina: Do you have any other tips or advice for anyone buying, selling or appraising a business?

Elliott: If the buy-in is going to occur over a period of years, then the best advice I can give to both the seller and the buyer of a business is to make sure you know the other person. Know his or her work expectations after the selling process commences. Know his or her work ethic. Know what his or her strong suits are, and know weaknesses too.

I was once an advisor to the sale of a health care professional practice that involved three parties. One individual, a medical doctor, was selling minority stakes to two other individuals using seller financing . One of the buyers was also a medical doctor within the practice and the other handled more of the administrative heavy lifting but was partially involved in the professional aspect when fill-ins were needed.

About six months after the initial purchase of stock, the seller and the doctor were completely at odds with one another. There was an apparent disconnect in expectations of the other party. The buying doctor assumed that buying in to the practice equated to new privileges and freedom to delegate. He began working fewer hours. He asked subordinates to perform tasks for which only he was qualified. He took on no new responsibilities, but he gained a substantial raise. The seller on the other hand expected a long needed reduction in work hours and responsibilities. He was looking forward to transitioning his focus on other aspects in life.

As you can probably guess, it did not end well. The two parties ended up settling outside of court, with the buyer receiving the fair market value of the few shares he owned unfortunately. The take-away here is not only to know the expectations of the other party, but also document them. It may seem petty to some to contractualize job tasks, but it could save you a lawsuit.

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