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Why NPV Matters, Sometimes

Based on Reggie’s comment, it seemed his mind

To which he replied, “Well, I would have thought that $35 million would be enough of a reason, but you are the pro, I’ll set aside the time to go through your process.”

We pulled out a whiteboard and listed the company’s strengths, weaknesses, opportunities, and threats

im, you are a unicorn, 98% of the M&A intermediaries or brokers don’t know what net present value is, much less provide this level of analysis for their clients.”

I define “near-term” as the next five years. Simply said, should the owner sell now or hold a few more years?

This analysis tells the business owner what the business is worth today to the business owner, and that number is the benchmark they have when considering offers to sell their business.

What’s right for the client is literally all that matters, even if it means losing out on a really nice engagement. Thinking long term benefits everyone, eventually.

Why NPV Matters, Sometimes

Image of chartWhat do you mean you don’t want to sell my business? I thought that’s what you did for a living?” Reggie (not his real name) would have been the ideal client. His business was growing and extremely profitable, EBITDA of $3.57 million last year and forecasted to be $4.25 million this year.

Reggie called me a couple months ago after returning from an industry conference in Orlando where he met several private equity firms that were searching for businesses like his. “They were tossing around EBITDA multiples of 7 to 8, one guy even said maybe 9. You know, that’d be a lot of money.” Based on Reggie’s comment, it seemed his mind was already made up, he was ready to sell his business.

I was excited and honored to be on the verge of this compelling engagement. Reggie could likely sell his business for $35+/- million.  I can’t lie, I did a quick mental calculation and the fee I would make would be nice.

I told Reggie we would need to spend a few hours together working through all the factors related to making a decision to go to market. I think he was surprised to learn I wasn’t immediately jumping on the bandwagon to sell. To which he replied, “Well, I would have thought that $35 million would be enough of a reason, but you are the pro, I’ll set aside the time to go through your process.”

I met with Reggie in his conference room a few days later. The first part of our meeting was to evaluate how a buyer would see his company, what I call “the seven principles of irresistibility.” I have a template that scores the potential client on each of the seven principles. https://tnvalleygroup.com/grade-your-company-quiz/.

How a company scores on my test tells me a lot about its marketability. The second part of our meeting we completed a SWOT analysis of his company. We pulled out a whiteboard and listed the company’s strengths, weaknesses, opportunities, and threats. I take my prospective clients through this SWOT exercise for three reasons. First, it helps the business owner come to grips with the imminent future of the business. Does the future look exciting (strengths & opportunities) or precarious (weaknesses & threats)? Once they’ve taken a dispassionate perspective on the future, the logic behind their decision to sell, or not sell, becomes clearer. Second, the information I glean from the SWOT exercise forms the guts of the confidential information memorandum I will write if the decision is made to go to market. Finally, this SWOT exercise helps me determine what the discount rate should be when we start the next phase of our meeting, determining the company’s net present value. Keep in mind, this is all before the client has made a decision to sell, and they’ve paid me no fee to this point. I will never be that guy who subtly forces an owner into selling just to get an engagement.

Incidentally, I had an attorney at a prominent Nashville law firm once say “Jim, you are a unicorn, 98% of the M&A intermediaries or brokers don’t know what net present value is, much less provide this level of analysis for their clients.”

Now, explaining net present value could justify a couple thousand words. But the essence of the concept is this: a net present value analysis tells the business owner the value of the company today based on how the owner projects near-term revenue and expense. I define “near-term” as the next five years. Simply said, should the owner sell now or hold a few more years?

My analysis takes the owner’s five-year projections, then discounts them to today based on an interest rate that captures the time value of money and the risk associated with continuing to operate the company over that five-year period.  This analysis tells the business owner what the business is worth today to the business owner, and that number is the benchmark they have when considering offers to sell their business.

To be clear, net present value has nothing to do with market value, and that’s the point! Net present value is what the business is worth today to the business owner. Logically, if the net present value of the business is greater than the market value of the business, the business owner should not sell.

After our analysis together, I recommended to Reggie that he not take his company to market. Though the market value of his business seemed to be in the $35+/- million range, the net present value of his business was in the low $40 million range (even after assuming a risk-adjusted discount rate). Simply said, unless he could get an offer in that low $40 million range, he should not sell today.

This kind of analysis is why my practice does not just have a “client first” focus, but a “client only” focus. What’s right for the client is literally all that matters, even if it means losing out on a really nice engagement. Thinking long term benefits everyone, eventually.

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Tennessee Valley Group

Jim is an attorney (non-resident status with the Missouri Bar) and though he no longer practices law, he has read and negotiated enough legal documents to fill a cargo tanker. He has an MBA from Harvard Business School and knows how Wall Street and private equity operates. Jim is a Tennessee Supreme Court Rule 31 listed general civil mediator with tons of experience helping business owners (large and small) work through sensitive problems to achieve winning results. He is the author of "Home Run, A Pro's Guide to Selling Your Business, Seven Principles to Make Your Company Irresistible."

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