Your friend’s business, Similar Stamping, was a lot like yours, MY Stamping. You both had revenues of about $20 million, net income of $3 million and you both produced metal stampings.  Your friend sold Similar Stampings last year.

He told you the price was $15 million and the process took only six months. His experience got you thinking that perhaps you could retire now. However, MY Stamping has been on the market for 14 months, and the best offer you have received is only $9 million. Why did his business sell for so much and yours hasn’t received the price you expected?

A number of factors could be at work.  Maybe your friend got lucky with timing.  You’ve been trying to go it on your own.  Perhaps the fees he paid to a professional advisor were worth it. Or, possibly, your businesses were not as similar as you thought. In order to understand why two seemingly similar businesses sell for different amounts, it is important to understand what factors might affect the sale of a business and what drives the value of a business.

There is a lot more to valuing a business than the numbers on the financial statement. To understand the value of a business, you must ask questions and dig for answers. It takes a lot of effort, but the payoff is a solid understanding of value and how to increase that value. You will also have the information necessary to make the right decisions for your future.

Value Drivers
Other than the psychological satisfaction of being the owner – getting in before and leaving after everyone else, worrying about whether your customer will renew next year’s program, losing sleep over whether your bid won because you made a mistake – the only reason to own a business is the cash flow it can produce. The value of a business is a function of its expected cash flows, the timing of those cash flows and the riskiness of those cash flows. In order to understand why your business is not selling for the price you expected and in order to improve the value of your business, you must examine a number of factors.   

Many things can impact the timing and riskiness of cash flows. Similar Stamping and MY Stamping both had $20 million in revenues and both sold into the automotive OEM supply chain. However, while, 95 percent of your sales are to the automotive OEM supply chain, your friend’s business is only 25 percent automotive. Ap­proximately 25 percent of his sales are to medical device manufacturers, which was a hot area for private equity firms buying businesses when your friend was trying to sell. The re­maining 50 percent of his sales are to an array of markets, with none accounting for more than 10 percent of sales. Also, 55 percent of MY Stamping’s sales are to one customer. Similar Stamping, meanwhile, does not have any client who accounts for more than 5 percent of his sales.    

The timing of your friend’s cash flows also turns out to be better. Since 95 percent of MY Stamping’s sales are to the automotive OEM supply chain, customers who pay late, yet still try to take an early pay discount, are a fact of life. Similar Stamping’s accounts receivable, on the other hand, are for the most part current, with very little bad debt. In fact, in one of the industries he serves, customer deposits at the time the order is placed are customary. So while your companies are similar in revenues, the timing and riskiness of the cash flows those revenues produce aren’t the same.

Working Capital
Since so many of MY Stamping’s sales go to just-in-time manufacturers, you keep large amounts of inventory so that you are never late on a shipment. A large portion of Similar Stamping’s sales, on the other hand, are custom order, and so in addition to receiving a deposit at the time of order, Similar Stamping does not order raw materials until an order is placed. Therefore, Similar Stamping keeps very little in the way of finished goods. You both buy from mostly the same suppliers, so your terms with your vendors are about the same.   

Because your friend’s business has lower inventory, collects its accounts receivables more quickly and has terms with vendors similar to yours, his working capital needs are lower. Generally, the lower your working capital requirements, the more valuable the business.

Machinery and Equipment
You have been considering buying a new press for a year or two. While yours still works, you are concerned that it is getting old and afraid that down time and maintenance costs will start to go up. A new press would allow for faster throughput. It would also allow quicker changeovers, lessening down time and allowing you to produce smaller lots. Smaller lots means reduced needs for finished goods. You just haven’t been able to decide whether to invest the money.

Actually, what got you thinking about new equipment was that Similar Stamping bought the same press about a year before your friend sold his business and he couldn’t stop talking about the improvement to his business.

Revenue Growth
While the economy, particularly the downturn in the automotive industry, has been hard on your business, you have been able to hold your own in terms of revenues. Your friend, on the other hand, had begun investigating new markets for Similar Stamping several years earlier. Some of the stampings he was producing for the medical device market were for new products that had good growth potential. As those sales grow, your friend’s business will grow, as well.

Management Team
It doesn’t seem fair. Your friend never seemed to work quite as hard as you, yet he was able to sell Similar Stamping for more than it looks like you will be able to sell MY Stamping. While you haven’t had an uninterrupted vacation in years, your friend was able to take time off to golf and sail his boat during the summer and to ski in the winter. He kept a close eye on his business, but he put a solid management team in place, a team who could handle whatever came up while your friend was away.

He kept in touch with the major customers, but sales and customer service were also in regular contact with all of the customers. When it came time to sell, the buyer could see that the senior management team at Similar Stamping could manage the business for them, as well. They also had fewer concerns about whether the customers would continue doing business once they found out your friend had sold because they knew the relationships were at multiple levels of Similar Stamping, not just with your friend.   

You, on the other hand, are involved in every decision. If customers need something, they don’t call customer service, they call you. Buyers, therefore, are concerned about whether your management team can run MY Stamping without you and whether customers will decide to look elsewhere after you have sold.

Timing and the Economy
Your friend began his sales process in November 2007 and closed his sale in April 2008. You, unfortunately, did not commit to selling until June 2008. By the time you took your company to market, the economy had already begun declining. Potential buyers were more concerned about maintaining their businesses through the downturn than they were about acquisitions. To make matters worse, the credit market got much tighter, and buyers who were still active could not leverage acquisitions as highly as when your friend sold his firm.

What is Motivating the Buyer?
The buyer for Similar Stamping company needed manufacturing capacity. The buyer was running three shifts and afraid it could not meet demand. Since Similar Stamping was running only one shift, the buyer expected to immediately make better use of the Similar Stamping’s fixed assets by moving some production for existing customers to your friend’s plant, freeing up capacity at their main plant for customers with increasing demand.   

Also, Similar Stamping was ISO 9000-certified while the buyer was not. Furthermore, Similar Stamping was an approved vendor for certain large automotive suppliers. By buying your friend’s company, the buyer could immediately begin selling to customers they could not sell to before and introduce manufacturing capabilities to these existing customers of your friend’s business, increasing their sales almost overnight.

Better Sale Process
Your friend used the help of a professional advisor to sell Similar Stamping. When you heard that your friend had to pay a percentage of the selling price to the advisor, you decided to go it alone. After all, you have been in charge of sales for MY Stamping for years, so you could also sell the company, right? You have since found out how difficult it is to find and screen buyers. And negotiations with the two buyers who looked like they might be interested never went beyond an initial offer. After much back and forth, both offers fell through.   

You are now having second thoughts about going it alone. You complained to your friend about how difficult and time-consuming the sales process is and how it is distracting you so much from running your business that you are afraid your sales might begin to suffer. You also told him how hard it is to find buyers, how you can never tell if a buyer actually has the financial wherewithal to close the sale and how unreasonable buyers can be. Your friend said none of that was a problem for him. He explained he only talked to a few buyers after his advisor had negotiated a favorable deal and investigated their ability to pay. You are now really questioning your decision to go it alone.

Terms of the Deal
Your friend said his business sold for $15 million. However, what he did not tell you was that the $15 million consisted of $12 million cash at closing and a $3 million earn out over the next 24 months. So while your friend’s business still sold for substantially more cash at close than the offers you are receiving, it is “only” $3 million more in cash and the possibility of more from the earn out rather than the $6 million you thought it was.   

Determining the value of a business requires training and experience. But once you understand what drives value, you are closer to knowing how to in­crease the value of your business.