Why I Might Turn Down a Perfectly Great Engagement (part 2)

Reggie thought I was crazy, at first. He knew I was walking away from a very large fee. I told Reggie I didn’t want to represent him, even though the market value of his company was about $35 million. Well, to be more exact, I told him he shouldn’t sell his company right now, at least not for the $35 million market value.

It seems oxymoronic to tell a business owner their business is worth more than market value. In theory, a business is only worth what someone is willing to pay, right? Well, not really.

There is a financial theory called “net present value” which is a way of understanding what something is worth today to the person making the evaluation. Net present value is how astute publicly-traded companies make capital allocation decisions, yet it’s an evaluation tool seldom used by owners of privately-held businesses. But I use net present value to help my prospective clients determine if and when they should sell their business. Frankly, it doesn’t happen often, but there are occasions like Reggie’s when the net present value of a business is greater than its market value. When that happens, it might be time to put brakes on the selling process.

Here’s how this happened. Reggie knew there were several companies interested in buying his business. He had been told he could get as much as $35 million. To assess his options, Reggie and I sat down to evaluate the growth of his business over the next five years, and from that, we prepared a five-year cash flow forecast. We then made a conservative forecast of what the market value of his company would be at the end of that five-year period. Of course, nothing is certain, so we then looked at all the risk factors that might affect his business over those next five years, and from that, we decided on a discount rate. We then applied that discount rate to that five-year cash flow forecast, inclusive of the assumption he’d sell the business at the end of that five-year period. Presto, that analysis gave us the net present value of his business, which came to $41.5 million.

So you ask, why would a business have a higher net present value to an owner than to a prospective buyer? There are two reasons this can happen. First, the owner might have a better handle on the future and/or more confidence about future results. Second, the buyer might have less risk tolerance about the required investment, which means their discount rate would be higher, which equates to a lower valuation.

I advised Reggie that he had several options. First, he could sell for the market value, about $35 million; while that amount is less than we think it’s worth, if he’s ready/needing to sell, that’s a not a bad walk away number. His second option would be to forget about selling now and focus on running the business to achieve the five-year forecast. In the course of doing that, the market value might catch up with his present value. Finally, I suggested to Reggie that we could show the potential buyers our net present value analysis and how we got to $41.5 million. Now, would our analysis cause them to change their assumptions and resultant valuation? Maybe/maybe not. But this explanation would set the bar for the next round of negotiations, and the buyer would know our objectives and logic.

But there’s an additional benefit to showing a potential buyer your net present value analysis. A thoughtful and sophisticated analysis of your perception of the future will almost always lead a potential buyer to want your business more. The buyer will appreciate your attention to detail and the astute planning that led you to complete the net present value analysis in the first place. The seller wins, however it shakes out.

JIM CUMBEE is President of Tennessee Valley Group, Inc. a retainer-based business brokerage and transition mediation firm in Franklin, TN. Cumbee is an attorney and has an MBA from Harvard Business School. Jim is the author of Home Run, A Pro’s Guide to Selling a Business. https://www.amazon.com/Home-Pros-Guide-Selling-Business/dp/1599329239 .  He has a wide range of corporate and entrepreneurial experiences that make him one of the most sought-after business transition advisors in the state of Tennessee. The story above is true, but the names and fact patterns above have been changed to preserve the parties’ identities.

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Tennessee Valley Group

Jim Cumbee established Tennessee Valley Group to help business owners fulfill their dreams for life after business ownership. It’s a mission that his 30+ year career history had prepared him well for—in addition to being an attorney, transition mediator and business broker, Jim has been a buyer, seller, and entrepreneur. His broad range of experience gives him unique insight into how business buyers and sellers can achieve their goals.

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