Determining and Increasing the Value of Your Business
by Marc DiPaolo

A business' value is not based solely on its profitability, but on its efficiency, its product, and its customer base. The strengths of a small business (which, technically, is any business with less than 500 employees) include its agility, speed, talent, and user base. All of these strengths constitute reasons why a larger business might seek to buy out a smaller one, explained Robert J. Chalfin, a speaker at an NJTC presentation "Valuing Your Company." A large company might be interested in purchasing a small business to obtain its management structure, its technology, and its customer base. The purchase may also afford the big business the opportunity to expand its product line, diversify, or increase its cash flow-profits.

"Most businesses are bought for their management," said Chalfin, the Metuchen-based founder of The Chalfin Group, Inc. "Remember, Apple had a better operating system and Windows had better management. People buy businesses today for people."

Chalfin feels that small businesses are valuable if they have a valid business model, demonstrate management and organizational depth, sport cutting edge technology, a broad and diversified customer base, and have an effective marketing and sales force. In addition, strong businesses show growing revenues, increased earnings, predictable cash flow, reliable funding sources, and good documentation.

"Have an audited financial statement," he said. "It'll make your business much easier to analyze, and it'll look healthy. Get your competitor's financial statement and make yours look like theirs to show compatibility." Also included in Chalfin's idea of good documentation is a three-page executive summary, continually updated on the company website, that should express the business' mission in layman's terms so that non-technical types can read it with comprehension.

Although Chalfin made the point with humor, he further advised business owners to avoid using company funds to finance extra-curricular activities.

"Get your girlfriends, boats, bourbon and scotch off the payroll," he said. "I understand it's a common practice, but keep in mind the ramifications. The real successful businesses don't screw around with the books. They're too busy buying and selling to bother keeping two sets of books. Long-term, you're making a mistake if you're horsing around."

Other ways of increasing value include distribution agreements, technology license, minority investment, buying options on the business, venture investments, marketing or strategic alliances, joint ventures, combinations such as Roll-Ups, selling the business, and initial public offerings.

Although value increases if a business is to allow it to grow organically, only one in five business owners want their business to grow. The rest fear that growth will cause the business to evolve beyond them, Chalfin said. "When the business starts evolving beyond what you are comfortable with, then maybe itÕs time to sell," he said. "It's a rare entrepreneur that wants to give up his business. Most entrepreneurs die with their boots on." For Chalfin, the best time to sell a business is when it is prospering, and when it is still fun to operate. "When should Steinbrenner have sold the Yankees? Right after 1998 when they won 125 games, because it'll never get any better than that," he said, explaining that timing is probably more important than ever in selling a business.

However, Chalfin cautioned against selling off the company too quickly by jumping at the first offer. "You're never only going to get one offer. You're going to get more. The market is right, so if the time is right for one person to buy you, the time will be right for another. There's a tremendous amount of capital out there, if your business has a product." Chalfin stressed that cash is preferable to stock options when you are being paid for your company, because cash is concrete, and if the stocks drop after you're given the options, you could conceivably lose three years worth of work.

When contacting potential acquirers, it's important to be discreet and meet them at third party locations to prevent perceptive employees from getting wind of the talks, he advised. Also, Chalfin urges checking up on the potential acquirers to make sure they are people who would lead the business into a successful future. Do they have a history of treating clients and employees well? And are they serious bidders? "Sometimes people pose as buyers to get info," Chalfin said. "Check if they are the types of people to do the deal. But don't be too paranoid. You can let them know what you're doing by releasing the information in stages, the executive summary coming first. Don't throw the confidentiality agreement in their face up front."

But if you were the buyer, and could request only five items of information about the target business, what should you request? For Chalfin the answer is simple: Tax returns and financial statement information, employee profiles, projections, and marketing data. If you're the buyer, you must also be concerned about giving the target company's staff incentive to stay on after the changeover. "You want to discuss compensation plans and stock options, any way to keep people," he said.

One valuation method for a company involves the sales or revenue multiple. This refers to the ratio or multiple of the business' sales or revenues to its market value, though this method might not work for companies whose revenues may vary significantly in the near future. Another valuation method is the earnings multiple, which is the ratio of the business' earnings to its market price, though start-up companies cannot be properly valued using this method. A company may also be valued based on the cash flow it generates, or valued on the private equity model, or on the cost of replacing its technical or intellectual capital. The internal sales method considers interests in the business that may have been purchased. One might also look at similar companies that have recently changed hands and what those companies were purchased for in determining value. The Internal Rate of Return method discounts the company's profits over a period of time to determine its current value. Book value rates the company based on the value of its assets and liabilities as listed on the balance sheet. Liquidation value considers what the company would be worth if the business were liquidated.

Interestingly enough, Chalfin said small business owners often drastically underestimate the true value of their businesses, so these methods may help such owners better understand the valuing process.