Will appear on BV pages – RECENT VALUATION ARTICLES

Reconciling Value in Business Valuation: Beyond Implied Multiples

/in , /by Victor Vazquez

Executive Summary

Most private-company acquisitions are structured on a cash-free, debt-free (CFDF) basis. Owners hear this all the time — but many don’t fully appreciate how much it shapes their actual proceeds.

In simple terms, the buyer purchases the operating business, not your cash or your debt. You keep your cash, and you pay off your debt at closing — similar to paying off a mortgage when selling a house.

That sounds straightforward and the letter of intent (LOI) typically states that the deal is CFDF. But what counts as “cash” and what counts as “debt” is negotiated, and those definitions can meaningfully affect your outcome.

Working Capital: Where Deals Are Won or Lost

Buyers expect a business to come with a normalized level of working capital so it can operate smoothly on day one. Think of it like buying a car — it needs some gas in the tank. But here’s a critical distinction: M&A working capital is not accounting working capital.

In a transaction, working capital is usually calculated as:

  • Assets: Accounts receivable + inventory + prepaid expenses
  • Minus liabilities: Accounts payable + accrued expenses

Cash, interest-bearing debt and other “debt-like” items are excluded from working capital. This matters because working capital and debt-like definitions drive purchase price adjustments at closing. Debt like items are deducted from the seller’s proceeds, dollar for dollar.

What Counts as “Debt-Like”?

Executive Summary

In business valuation, reaching a value conclusion is only part of the analytical process. Professional standards emphasize the importance of reconciling that conclusion to ensure it is economically reasonable and consistent with market evidence. Analysts often compare implied valuation multiples to market benchmarks, but another useful perspective is evaluating the relationship between the concluded equity value and the tangible and intangible assets that support the company’s earnings.

Why Reconciliation Matters?

Professional standards, including the American Society of Appraisers (ASA) Business Valuation Standards, AICPA Statement on Standards for Valuation Services No. 1 (SSVS No. 1), and IRS Revenue Ruling 59‑60, emphasize that valuation requires informed professional judgment. No single formula determines value; analysts must evaluate multiple factors and ensure that their conclusions align with economic reality.

Using Implied Multiples

After deriving a value using an income or market approach, analysts can calculate the implied EBITDA, EBIT, or revenue multiples embedded in the conclusion. These can then be compared to multiples from guideline public companies or transactions in the relevant industry. If the implied multiples fall within a reasonable range, the conclusion is generally viewed as directionally consistent with market evidence.

Considering Intangible Assets

Another perspective is to examine the relationship between the concluded equity value and the company’s underlying assets. Conceptually:

Enterprise / Equity Value ≈ Net Tangible Assets + Identifiable Intangible Assets + Goodwill

If the concluded value significantly exceeds the adjusted net tangible assets, the difference represents the implied value of intangible assets and goodwill. Understanding whether that implied value is economically plausible can serve as another reasonableness check.

The 25 Percent Rule of Thumb

In intellectual property valuation literature, the so‑called 25 percent rule of thumb suggests that a licensor might capture roughly 25 percent of the economic profit generated by a licensed technology or brand through royalties. While widely discussed, the 25 percent rule of thumb should never be used as a primary valuation method. Courts and valuation professionals emphasize that royalty rates must ultimately be supported by market evidence.

In practice, the concept can occasionally serve as a high‑level intuition check when considering whether a royalty rate or implied intangible value appears economically plausible.

Conclusion

Reconciling a valuation conclusion involves ensuring that the analytical framework forms a coherent economic narrative. When implied multiples align with market evidence, and the relationship between tangible and intangible assets appears reasonable, analysts gain greater confidence that their conclusions are defensible under professional standards.

Exit Strategies values control and minority ownership interests of private businesses for tax, financial reporting, and strategic purposes. If you’d like help in this regard or have any related questions, you can reach Victor Vazquez, ASA, MRICS at 707-415-2218 or vvazquez@exitstrategiesgroup.com.

What “Cash-Free, Debt-Free” Really Means When You Sell Your Business

/in , /by Al Statz

Most private-company acquisitions are structured on a cash-free, debt-free (CFDF) basis. Owners hear this all the time — but many don’t fully appreciate how much it shapes their actual proceeds.

In simple terms, the buyer purchases the operating business, not your cash or your debt. You keep your cash, and you pay off your debt at closing — similar to paying off a mortgage when selling a house.

That sounds straightforward and the letter of intent (LOI) typically states that the deal is CFDF. But what counts as “cash” and what counts as “debt” is negotiated, and those definitions can meaningfully affect your outcome.

Working Capital: Where Deals Are Won or Lost

Buyers expect a business to come with a normalized level of working capital so it can operate smoothly on day one. Think of it like buying a car — it needs some gas in the tank. But here’s a critical distinction: M&A working capital is not accounting working capital.

In a transaction, working capital is usually calculated as:

  • Assets: Accounts receivable + inventory + prepaid expenses
  • Minus liabilities: Accounts payable + accrued expenses

Cash, interest-bearing debt and other “debt-like” items are excluded from working capital. This matters because working capital and debt-like definitions drive purchase price adjustments at closing. Debt like items are deducted from the seller’s proceeds, dollar for dollar.

What Counts as “Debt-Like”?

Beyond bank debt, buyers often try to treat certain items as “debt-like,” meaning these items reduce seller proceeds at closing. Common examples include:

  • Equipment leases
  • Accrued bonuses or commissions
  • Accrued PTO
  • Unpaid taxes
  • Deferred revenue
  • Customer credits or gift cards
  • Warranty liabilities
  • Pending legal claims
  • Unfunded pension obligations

If it looks like a liability, buyers will want to treat it as one.

The Working Capital Target (or “Peg”)

The working capital target is meant to reflect what the business normally needs to run. The most common method is to average working capital over recent months.

If actual working capital at closing is below the target, the purchase price is reduced. If it’s above, the seller receives a credit.

In theory, the working capital target should be neutral to both sides. In reality:

  • Buyers tend to push for a higher target.
  • Sellers tend to push for a lower target.

This single adjustment can swing millions of dollars, which is why it deserves attention early in the process.

Enterprise Value vs. What You Actually Get Paid

Buyers quote enterprise value (EV) — but sellers care about equity value, which is what actually gets wired at closing.

The basic formula is:

Equity Value = Enterprise Value + cash – debt ± working capital adjustment

Example:
You own a manufacturer generating $5 million of EBITDA. A buyer offers $30 million (6 × EBITDA) — that’s enterprise value. Let’s say at closing you have:

  • Cash: $1M
  • Debt and debt-like items: $3M
  • Working capital today: $3M (vs agreed working capital peg: $4M)

Net proceeds = $30M – $1M (working capital shortfall) – $3M (debt payoff) + $1M (cash you keep) = $27M.

This is why focusing only on the multiple can be misleading — the adjustments determine your real outcome.

What Smart M&A Advisors Do

Strong sell-side advisors don’t just manage a process — they protect value before, during, and after diligence. The best advisors:

  • Pressure-test the balance sheet early to surface “debt-like” items.
  • Model working capital multiple ways so there are no surprises or disputes later on.
  • Negotiating tighter working capital and debt language in the LOI rather than deferring it.
  • Anticipate buyer adjustments in diligence and prepare counter-arguments.
  • Translate headline valuation into real net proceeds for the owner.
  • Create competitive tension among buyers to strengthen negotiating leverage.
  • Run a disciplined closing process where value is most vulnerable.

In M&A, getting the deal signed is important — getting the dollars right is everything. The goal isn’t just a signed deal — it’s maximizing what actually hits your bank account.

If you’re considering a sale, start the conversation early. You can reach Exit Strategies Group founder and President Al Statz at alstatz@exitstrategiesgroup.com

Lessons Learned After Connelly Reflections from the October 2025 BVResources Webinar

/in , /by Joe Orlando

In January 2025, our firm published a blog on the impact of the Connelly v. United States case and how the court’s ruling has influenced business valuations. In October 2025, I had the opportunity to present at a Business Valuation Resources (BVR) webinar titled “Lessons Learned After Connelly: Valuation, Insurance, and Planning in Practice.” The session brought together valuation analysts, estate planners, attorneys, and advisors to examine how the Supreme Court’s 2024 decision in this case is reshaping the valuation and planning landscape. Although the ruling appears straightforward at first glance, its implications for buy-sell agreement design, estate tax exposure, and valuation methodology are significant.

As our prior blog detailed, the Supreme Court unanimously held that corporate-owned life insurance must be included in the value of a business for estate tax purposes. This sounds simple, but as we discussed during the webinar, the decision created new urgency around understanding how life insurance appears on the balance sheet, how redemption arrangements function, and how valuation professionals approach buy-sell structures. Many practitioners are now discovering issues that had gone unnoticed for years.

Clarity Around a Complex Decision

During the webinar, we reviewed the facts of the Connelly case, which involved two brothers who owned all shares of their company. Their buy-sell agreement (BSA) was funded with $3.5 million of corporate-owned life insurance. Although the agreement required regular updates to a Certificate of Agreed Value, none were ever executed, and no appraisal was performed during either brother’s lifetime.

When Michael passed away, the corporation received $3.5 million of insurance and was required to redeem his interest. The estate’s valuation excluded the insurance proceeds and relied on the position taken in Estate of Blount (11th Cir.). The IRS disagreed, asserting that the insurance proceeds were corporate assets and must be included in the company’s value. The Supreme Court ultimately affirmed the IRS position, noting that the redemption obligation was not a liability that reduced corporate value.

The decision surprised many. However, as we noted in the webinar, Connelly did not create new law. It simply reaffirmed existing valuation principles that require non-operating assets, including life insurance, to be included in corporate equity value unless already accounted for elsewhere. This is consistent with the valuation concepts outlined in Rev. Rul. 59-60 and Treasury regulations.

Valuation Takeaways for Practitioners

My portion of the webinar focused on valuation implications that closely mirror the guidance we share with clients when reviewing or valuing buy-sell agreements. Several themes stood out:

  1. Life insurance is a non-operating asset that must be included in value. Whether the proceeds are allocated for redemption does not change their status as corporate assets. Practitioners should treat entity-owned life insurance consistently with other non-operating assets.
  2. Many buy-sell agreements no longer reflect their intended purpose. We regularly encounter agreements that contain outdated formulas, vague valuation requirements, unclear pricing language, or poorly designed redemption arrangements. Connelly did not create these problems, but it magnified them.
  3. Benchmark valuations are an effective planning tool. As in our previous discussions with clients, establishing an initial valuation and periodically updating it can reduce disputes and increase certainty. This approach is consistent with the guidance we provide in our broader writing on valuation and buy-sell planning.
  4. Use secondary-market indications to benchmark fair value. Policy’s fair value often differs from cash surrender value (CSV) or Form 712. Health status and market demand, in most cases, make CSV an unreliable proxy.  Obtain life-settlement bids or an opinion supported by longevity analytics.
  5. Collaboration among advisors is essential. Because buy-sell agreements involve legal, tax, insurance, and valuation considerations, coordinated review is necessary. Connelly demonstrated what can happen when these areas are addressed independently.

Why This Matters for Private Companies and Advisors

For closely held businesses, the Connelly decision serves as a reminder that buy-sell agreements require regular maintenance. They are not static documents. If an agreement is not reviewed periodically, it can lose its relevance and fail to hold up under scrutiny. For valuation professionals, the decision reinforces the importance of understanding how insurance-funded redemption structures affect equity value, estate tax exposure, and appraisal methodology.

As noted in our earlier writing, effective buy-sell agreements provide an orderly transfer mechanism, restrict ownership appropriately, create liquidity for departing shareholders, and include a clear and supportable valuation process. These principles remain unchanged, but the need for careful drafting and regular review has increased.

Looking Ahead

The strong engagement during the webinar reinforced that advisors are actively adjusting their planning approaches in a post-Connelly environment. As clients revisit their agreements or consider new valuation benchmarks, it is important to ensure that insurance structures, valuation methods, and legal provisions are aligned.

Built on our firm’s many years of institutional experience and knowledge in helping clients structure and update BSAs, we utilize a proprietary database of the terms associated with BSAs to present the topic of “Avoiding Landmines in Buy-Sell Agreements: A Business Valuation Expert’s Perspective” to attorneys and CPAs for CPE credit.

If you are interested in having us present this topic to your professional staff for CPE credit, please get in touch with Joe Orlando at 503-925-5510 or jorlando@exitstrategiesgroup.com for more information.

Using Financial Benchmarking to Maximize Business Performance and Value

/in , /by Al Statz

If you want to run a stronger business and ultimately sell it for a premium, you need to know how your company stacks up against peers. That’s where financial benchmarking comes in—one of the most overlooked, yet most powerful, tools for value creation.

At Exit Strategies Group, we rely on benchmarking in our valuations and exit assessments because the message across thousands of real-world M&A transactions is clear: businesses with above-average performance and growth earn above-average multiples. Period.

Here’s how benchmarking helps you sharpen performance, boost enterprise value, and prepare for a successful exit.
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Why Benchmarking Matters

Most owners know their numbers; few know how those numbers compare to others in their industry. Benchmarking gives you that clarity—and once you see the gaps, you can act.

Sharper Decision-Making
Benchmarks reveal whether your strategies are working or drifting. You stop managing on instinct and start managing on data.

Pinpoint Growth Opportunities
Lagging margins? Bloated inventory? Slow receivables? Benchmarking quickly highlights where improvement will have the biggest impact.

Measure Real Progress
Tracking benchmarks over time shows whether changes are actually moving the needle.

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Core Ratios That Drive Value

1. Profitability Ratios

Profitability is the engine of valuation.

  • Gross Margin – What you have left to cover overhead and generate earnings.
  • Net Profit Margin (EBT, EBIT, or EBITDA Return on Sales) – Should expand as revenue scales and fixed costs spread out.

A simple truth: if your net margin is 12% and peers average 20%, you’re not just behind—you’re limiting your valuation.

2. Efficiency Ratios

These indicate how effectively you manage working capital—the lifeblood of cash flow.

Examples:

  • Inventory Turnover
  • A/R Turnover
  • Days Payable Outstanding
  • Cash Cycle
  • Working Capital Turnover

Shorter cycles and higher turnover generally mean better cash flow and higher value.

3. Leverage & Solvency Ratios

These ratios reflect financial risk—yours today and a buyer’s tomorrow.

Examples:

  • Interest Coverage
  • Capital Structure (debt as a % of total capital)

If leverage is high or coverage is weak, the business starts to look constrained and risky—two words buyers do not reward.

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How to Use Benchmarking to Drive Value

1. Compare Your Numbers to Industry Norms

Sources like IBISWorld, RMA, BizMiner, and industry associations provide reliable benchmarks.
If your performance is materially below the standard, you’ve found actionable value levers.

2. Get an Expert to Interpret the Data

Ratios don’t tell the whole story.
Differences in business models, customer mix, capital structure, and accounting can all distort comparisons. A valuation expert or M&A advisor helps separate signal from noise, and determine underlying causes and opportunities for improvement.

3. Set High-Impact, Realistic Targets

You don’t need to fix everything at once. Improving one or two key ratios can materially raise enterprise value.

4. Monitor Consistently

Quarterly benchmarking keeps your team focused, exposes emerging issues, and reinforces continuous improvement.

Summary

Benchmarking isn’t an accounting exercise—it’s a strategic weapon. It clarifies strengths, exposes vulnerabilities, and identifies untapped value. If your goal is to build a more resilient, profitable company—and eventually exit at a superior valuation—financial benchmarking should be part of your operating rhythm.

Exit Strategies Group helps owners understand where they stand and turn data into actionable value-creation plans.

If you’re ready to unlock more value, let’s talk; you can reach Exit Strategies Group founder and President Al Statz at alstatz@exitstrategiesgroup.com .

THE IMPORTANCE OF BUY-SELL AGREEMENTS IN BUSINESS CONTINUITY

/in , /by Joe Orlando

For business owners, a well-structured buy-sell agreement is essential for ensuring a seamless transition of ownership in the event of death, disability, or retirement. These agreements define who has the right to purchase ownership interests and at what price, mitigating potential disputes among partners, heirs, and buyers.

Valuation: A Critical Component

A properly structured buy-sell agreement includes a clear valuation method to determine the fair market value of a departing owner’s shares. Common valuation approaches include:

  • Business appraisal – An independent assessment by a business valuation expert(s) based on fundamental business valuation methodologies and the prevailing market conditions.
  • Formula-based calculations – Methods such as EBITDA multipliers, revenue multiples, or asset-based valuations.

To maintain fairness and accuracy, business owners should:

  1. Select an appropriate expert to determine the appropriate valuation methodologies that reflect the company’s fair market value.
  2. Review and update valuation methodologies regularly to align with market conditions.
  3. Avoid outdated valuation metrics, which can lead to financial disputes.

Lessons from Pappas v. B & G Holding Co.

A failure to update valuation terms led to a four-year legal battle in Pappas v. B & G Holding Co.:

  • William Egan, a 50% owner of B & G Holding Co., passed away, leaving his interest to a beneficiary, Dean George Pappas.
  • A pre-existing buy-sell agreement required the surviving partner, Eugene Leogrande, to purchase the shares at a predetermined price.
  • Pappas contested the valuation, seeking a fair market assessment instead of the agreement’s preset formula.
  • The court upheld the buy-sell terms, requiring Pappas to sell the shares for $318,348—likely based on an outdated rent-multiple valuation method.

Key Takeaways for Business Owners

  1. Review Buy-Sell Agreements Regularly – Ensure valuation methods reflect current market conditions. Outdated figures can significantly undervalue or overvalue a business.
  2. Update Your Valuation Annually – Some agreements require annual updates. These updates allow business partners the opportunity to assess value within their strategic planning process to identify ways in which to grow value.
  3. Prioritize Fair Market Value – Formula-based calculations become stale with new market data. Failing to update them may force reliance on outdated formulas. Market-driven valuations promote transparency and fairness.

Exit Strategies values control and minority ownership interests of private businesses for tax, financial reporting, and strategic purposes. If you’d like help in this regard or have any related questions, you can reach  Joe Orlando, ASA, at 503-925-5510 or jorlando@exitstrategiesgroup.com.

A Definitive Approach to Life Insurance and Share Redemption in the Valuation of Family-Owned Businesses

/in , /by Pete Wilson

In June 2024, the US Supreme Court, in a unanimous decision, ruled that proceeds from a corporate (or key person) life insurance should be added to the value of a business. Simple, right? So why is the decision in Connelly v. United States sending shockwaves through the valuation and estate planning exercises that go into an estate valuation?  Let’s dive into the case and talk through its impact.

Facts:

The case involved two brothers, Michael and Thomas Connelly, who were the sole shareholders of a corporation. They had a buy-sell agreement (BSA) in place, which was funded by life insurance policies held by the Corporation (as the beneficiary) on each other’s lives. The amount of insurance was $3.5 million for each brother. The buy-sell agreement was intended to ensure that upon the death of one brother, the surviving brother or the corporation could buy the deceased brother’s shares. The surviving brother had a right of first refusal with the Company required to buy the shares using the insurance proceeds if the surviving brother waived his right. When Michael passed away, Thomas did not buy the stock. The corporation was then required to buy the stock and used $3.5 million in life insurance proceeds to redeem Michael’s shares. An appraiser valued the business at $3.86 million and applied Michael’s ownership of 77.18% to this amount (or $2.98 million rounded up to $3.0 million). See calculations below.

ESTATE’S POSITION: 77.18% = $3.0 million

 

IRS Review:

The appraiser’s valuation of $3.8 million excluded the amount of the insurance proceeds used to buy out Michael’s estate and the Estate. However, the IRS took an opposing view, arguing that the overall value of the Company post-death was $6.86 million, $3 million in insurance proceeds used to redeem Michael’s 77.18% ownership plus $3.86 million of “other assets and other income generating potential”.[1] This substantial increase in the Company’s valuation and Michael’s interest ($6.86 million times 77.18% or $5.29 million), or an increase of $2.29 million. This increase raised the estate tax owed by $0.89 million, according to the Supreme Court’s calculation in the case syllabus.[2] See calculations below.

IRS’ POSITION: 77.18% = $5.3 million

 

Decision and Summary:

The Supreme Court ruled that the insurance proceeds were assets of the Company at the time of death and should be included in the estate. They argued that the obligation to buy the stock was not a liability; it was an equity obligation.[3]

References:

[1] Connelly v. United States, June 6, 2024. https://www.supremecourt.gov/opinions/23pdf/23-146_i42j.pdf

[2] Ibid.

[3] https://quickreadbuzz.com/2024/12/31/bv-kishel-caruso-valuation-lessons-from-connelly-v-united-states/

 

Valuation and Shareholder Analysis of Connelly

Impact:

The Connelly Decision clarified the valuation implications of using life insurance to fund buy-sell agreements. Additionally, it helped highlight the importance of ensuring that all key components of a buy-sell agreement are structured properly, especially in light of this ruling.

While we don’t draft BSAs, we provide feedback to our clients on the pros and cons of different pricing approaches and structures that are appropriate for each client’s circumstances and budget. Once armed with some ideas on how to structure these agreements, business owners should always consult with competent legal and tax counsel for additional feedback when drafting a buy-sell agreement. This process will help ensure that the contract is legally enforceable and that the business owner’s wishes are fulfilled.

Based on our read of hundreds of BSAs over the years, we have identified the following key characteristics of a properly planned and executed buy-sell agreement.

  • Facilitates orderly transfer of interests upon certain events, affordably, at fair and reasonable values;
  • Restricts who can own shares;
  • Provides liquidity for a selling shareholder AND a viable funding plan for the Company;
  • Increases visibility for planning: business, income tax, estate tax, retirement;
  • Is negotiated early on while shareholders are aligned, healthy, and harmonious; and
  • Is updated as conditions change

Specifically, as these BSAs relate to valuation, we note that most buy-sell agreements call for one, two, or three appraisers to determine value when a trigger event occurs. A multi-appraiser approach is more common with large companies and joint ventures. Small company BSA’s often suggest just one appraiser. Here are some thoughts on keeping us in mind for these valuations.

 

Exit Strategies Group:

As our clients prepare for this agreement, we recommend an initial benchmark valuation to quantify what is at stake and takes fear and mystery (and risk) out of the valuation process for the shareholders. Other than an initial valuation at the creation and execution of a BSA, we get involved in the following situations.

  • Appraise Upon a Trigger Event: Exit Strategies routinely appraises shares when a BSA is triggered. We can be selected after a trigger event or named in the agreement.

 

  • Periodic Valuations: Some buy-sell agreements call for annual or bi-annual valuations to maintain a current share price and help with buy-sell funding and planning. Exit Strategies provides initial valuations and updates.

 

  • Price Formula Design: Some buy-sell agreements, particularly for very small businesses, use a price formula. There are pros and cons of using a price formula in a BSA. Clients that take a formula approach often engage Exit Strategies to design a formula that is more robust (better tracks future value) and replicable. As part of this process, we typically perform a benchmark valuation and meet with all shareholders to explain our valuation and formula, as well as incorporate their feedback.

 

  • Buy-Sell Agreement Review: All buy-sell agreements, regardless of how well written, lose relevance over time and should be reviewed, tested, and updated periodically. We can review your BSA from business, economic, and valuation perspectives, identify potential problems, and recommend solutions. Sometimes, this includes testing a buy-sell price formula by performing the prescribed calculations or providing a business valuation for comparison. Performing an independent business valuation as part of a review can provide certainty and avoid surprises, time delays, and disputes later on.

 

Attorney and CPA CPE Offer:

Built off our firm’s many years of institutional experience and knowledge in helping clients structure and update BSAs, we utilize a proprietary database of the terms associated with BSAs to present the topic of “Avoiding Landmines in Buy-Sell Agreements: A Business Valuation Expert’s Perspective” to attorneys and CPAs for CPE credit. If you are interested in having us present this topic to your professional staff for CPE credit, please contact Joe Orlando at 503-925-5510 or jorlando@exitstrategiesgroup.com for more information.

 

Exit Strategies has certified appraisers who value control and minority ownership interests of private businesses for tax, financial reporting, and strategic purposes. If you’d like help in this regard or have any related questions, you can reach Pete Wilson at 510-590-7112 or pwilson@exitstrategiesgroup.com.

Give Yourself the Gift of a Valuation This Holiday Season?

/in , /by Al Statz

As the year winds down, there’s a gift every business owner should consider—a current valuation of your business. Knowing the true value of your business is a gift that keeps on giving. Here’s why.

Estate Planning

One of the key benefits of a valuation is that it sets the groundwork for smart estate planning. If the unforeseen happens, knowing your business’s worth simplifies the inheritance process for your heirs and ensures they receive what you intended. It can also help prevent disputes and legal entanglements that can arise when valuation estimates are murky or outdated.

Exit Planning

Whether you’re ready to step back next year or in the next decade, a valuation helps solidify your exit plan. With an accurate understanding of your business’s worth, you’re empowered to plan the best timing for a sale or transfer, negotiate confidently, and minimize surprises.  Unfortunately, studies show most owners spend very little time planning how they will exit their business. The smaller the business, the less likely the owner is to plan ahead—most start preparing less than a year before selling. This rushed approach can lead to a lower sale price, lost leverage in negotiations, failed transactions, and missed opportunities to boost the business’s value before hitting the market.

Build a Stronger Business Next Year

Even if a sale isn’t on your immediate horizon, the insights gained from the valuation process can guide strategic decisions to increase your company’s value over time. Knowing what adds or detracts from your company’s worth can help you decide on investments, operational changes, and growth strategies.

This holiday season, consider giving yourself a gift of increased clarity, direction, potential liquidity and peace of mind in the new year.

To learn more, see our prior post on the Six Benefits of Monitoring Company Value.

Goodwill hunting: How to build and finance this intangible asset

/in , , /by Al Statz

When it comes to selling a business, the term “goodwill” often arises. But what exactly is goodwill, and how does it impact the mergers and acquisitions (M&A) process?

Goodwill is the value of a business that exceeds its tangible assets. It arises when a company is sold for more than the worth of its physical assets such as equipment, vehicles and inventory.

Most successful companies have some level of goodwill, which is tied to cash flow. For example, consider a company with $2 million in EBITDA (earnings before interest, taxes, depreciation, and amortization) that sells for a 6 multiple, resulting in a $12 million valuation. If the company only has $5 million in physical assets, the remaining $7 million is considered goodwill.

Building goodwill. Goodwill is typically derived from the company’s ability to generate strong and consistent cash flows. Factors such as a loyal customer base, effective management team, a solid market position, and a unique value proposition all contribute to a company’s ability to generate cash flows above and beyond the value of its physical assets.

Goodwill can also be attributed to factors that de-risk the company. A strong brand, a large and diversified customer base, recurring revenue, a reliable supply chain—these are just some of the factors that give a buyer confidence they will be able to replicate performance and drive growth in the future. The more growth opportunities and less risk perceived by the buyer, the higher the multiple, and consequently, the more goodwill.

Financing goodwill. However, goodwill presents challenges when it comes to financing a deal. Goodwill is an intangible asset, which means it lacks the physical substance and clear valuation of tangible assets (again, such as equipment, vehicles, or inventory). Most traditional lenders, such as banks, often prefer to secure their loans with tangible assets that can be easily liquidated in case of default.

Moreover, the value of goodwill can fluctuate based on market conditions, industry trends, and the overall financial health of the company. If a business experiences a downturn or fails to meet its projected cash flows, the value of its goodwill may be impaired, leading to potential write-downs and negative impacts on the company’s balance sheet.

To overcome these challenges, businesses often need to explore alternative financing options or structures when dealing with significant amounts of goodwill. Seller financing or equity rollovers can help provide funding for goodwill, when traditional lenders won’t support it.

For smaller deals under $5 million, the Small Business Administration (SBA) offers loan programs that provide banks with a 75% guarantee, allowing them to take on more goodwill. For larger deals, strategic buyers with strong balance sheets, private equity groups, or family offices are generally better positioned to acquire a business with significant goodwill. These buyers can bring more

equity to the table or may already have alternative acquisition lending in place, such as mezzanine lenders

In the current deal market, most acquisitions above $10 million have a capital stack of 50% equity and 50% debt. Using the example above, that means the buyer would bring $6 million to the table and the senior lender (e.g., the bank) would only have about $1 million in exposure above and beyond the company’s tangible assets. That’s fairly palatable on a $12 million deal.

Allocating goodwill. When a business is sold, the purchase price is typically allocated among the various assets being acquired, including both tangible and intangible assets. However, the allocation of goodwill can have significant (and opposing) tax implications for the buyer and the seller.

In an asset sale, the buyer and seller will typically negotiate the allocation of the purchase price, considering the tax consequences for each party. The buyer generally prefers to allocate more of the purchase price to assets that can be depreciated quickly such as equipment, vehicles or other tangible assets, in order to maximize their tax deductions. The seller typically prefers to allocate more of the purchase price to goodwill, as it is generally taxed at a lower capital gains rate.

An indicator of success. At the end of the day, goodwill is a powerful sign of success. However, this intangible asset can also present challenges when financing an M&A deal. Business owners looking to sell their companies should be prepared to explore creative financing solutions and navigate negotiations around asset allocation. Experienced M&A advisors and tax professionals can help.

From the M&A Glossary: Add-backs

/in , /by Al Statz
Add-backs are adjustments made to a company’s financial statements to more accurately reflect its true earning potential and “normalize” its financial performance. These adjustments are typically made to the target company’s earnings before interest, taxes, depreciation, and amortization (EBITDA) to create a metric known as “Adjusted” or “Normalized” EBITDA.

Add-backs to EBITDA are expenses or income items that are considered definitional, discretionary, non-recurring, one-time, or not essential to the company’s core operations.

Common examples of add-backs include:

  1. Non-recurring:  These could include costs related to a lawsuit, restructuring, a natural disaster, or significant one-time investments.
  2. Owner’s compensation:  If the owner’s salary or benefits are higher than market rates, the excess may be added back to reflect the company’s true profitability.
  3. Discretionary expenses:  These are expenses that are not essential to the company’s operations, such as donations or excessive travel and entertainment.
  4. Non-arm’s length transactions:  These are business deals between related parties, such as family members, where the terms may not reflect fair market rates (e.g., real estate leases).
  5. Definitional: Interest, income taxes, depreciation and amortization are expenses that must be added back to net income to arrive at EBITDA

Properly normalizing financial statements is a learned skill that takes years of real-world M&A transaction experience. This is one of the many roles of an M&A advisor.

What Does ChatGPT Think?

/in , /by Joe Orlando

This October, I will celebrate my 12th year as an Accredited Senior Appraiser (ASA) in Business Valuation with the American Society of Appraisers (also ASA). ASA members meet every year for an International Conference to discuss current topics and to share knowledge and best practices. I attended the most recent Conference in Portland, OR. A presentation entitled “The AI Revolution – Why it Matters to Appraisers & Application Strategies” by Greg Endicott of Strategic Value Group, LLC summarized a BVResources Survey on AI as follows:

 

1.  Adoption: About 48% of business valuation (BV) firms are using AI, primarily for researching economic or industry conditions.

 

2.  Popular Tools: ChatGPT is the most popular AI tool, used by70%of respondents. Other tools include Copilot, Bard (now Gemini), and Grammarly.

 

3.  Concerns: 52%of firms are not using AI due to trust issues, data confidentiality concerns, and fear of AI “hallucinations.”

 

These takeaways were based on a survey of Business Valuation firms, not the general public. So, if about half of the BV firms surveyed are using AI, what can someone looking for a valuation get from asking a simple question into an AI engine?

 

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Here is the free answer a business owner gets from ChatGPT:

The “rule of thumb” in valuing a business as a multiple of EBITDA generally follows broad guidelines, depending on the business’s size, industry, and growth potential. Here’s a quick overview of common multiples based on these factors:

 

Rule of Thumb by Business Type/Size

1.  Small Businesses (less than $10 million in revenue):

o  3x – 5x EBITDA: Small businesses with modest revenue and growth potential usually command lower multiples due to higher perceived risks and less scalability.

 

2.  Medium-sized businesses ($10 million – $100 million in revenue):

o  5x – 7x EBITDA: These companies tend to attract higher multiples as they are more established, often with stronger growth prospects and greater market presence.

 

3.  Large Businesses (over $100 million in revenue):

o  7x – 10x EBITDA or more: Larger, well-established companies with stable cash flows, competitive advantages, and strong management teams often get higher multiples. These businesses are usually more attractive to institutional investors or private equity firms.

 

Rule of Thumb by Industry

1.  Low-Growth or Capital-Intensive Industries:

o  3x – 5x EBITDA: Industries like manufacturing, construction, and retail, which often have higher fixed costs and lower growth potential, typically have lower multiples.

 

2.  Moderate-Growth Industries:

o  5x – 7x EBITDA: Businesses in sectors like healthcare services, logistics, or consumer products generally attract mid-range multiples due to their stable but moderate growth prospects.

 

3.  High-Growth Industries:

o  8x – 12x EBITDA or more: Technology, software, and biotech companies with high growth potential and scalable business models can see much higher multiples, sometimes exceeding 12x EBITDA, especially if they have recurring revenue models.

 

Simplified Rule of Thumb:

For most small and mid-sized businesses in stable industries, a 4x to 6x EBITDA multiple is a common rule of thumb.

So, does this artificial intelligence have it right? Sort of. However, the above ranges and rule of thumb come with the implied caveat, “it depends…”

1.  It depends on the industry;

2.  It depends on the size of the revenue;

3.  It depends on the amount of EBITDA;

4.  It depends on the future growth of the Company and

5.  It depends on the risk in achieving this growth.

 

Historical Data in Support of ChatGPT Multiples

In testing these ChatGPT multiples, we looked at a database of actual transactions of lower middle market deals over the past few years. Below is a summary of rolling average EBITDA multiples for real deals up from the 4th quarter of 2020 through the 2nd Quarter of 2024. The data is compiled by GF Data, which collects and provides data primarily from private equity (PE) sponsors and other deal professionals involved in middle-market mergers and acquisitions (M&A). The data covers a range of metrics, including transaction multiples, leverage levels, and other deal terms, and is generally vetted and aggregated to protect the confidentiality of individual transactions while providing a robust data set for market analysis.  

As databases go, this one is pretty good. It has a statistically significant dataset populated and used by dealmakers. I like to use these multiples often to value businesses with significant EBITDA of at least $2 million or more. Here are the average multiples for all industries based on transaction enterprise value (TEV), by industry and by EBITDA size.

 

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Based on the above charts, GF Data does a good job supporting ChatGPT’s “rule of thumb” estimates for medium to large companies of 5x to 12x. However, because GF Data’s multiples are averages, they don’t specify outlier deals with lower and higher multiples than the 6.4x to 8.6x multiple ranges by industry.

 

For smaller deals,  we have used the Business Reference Guide as a strong “pricing guide” as our first iteration of value when discussing with a potential client a rough estimate of the value of their small businesses.

Conclusion

 

My conclusion is that ChatGPT does of job of cobbling together a starting point for a discussion on the value of your business, but it doesn’t do the job of a business valuation appraiser or M&A advisor. Use ChatGPT like you use Zillow.com to value your house. The multiples above will give you a very rough estimate of the value of your business. However, this first iteration will not suffice for compliance (litigation as well as gift, estate, or income tax) or strategic (exit planning, assessment for sale, or merger) purposes.

 

Exit Strategies values control and minority ownership interests of private businesses for tax, financial reporting, and strategic purposes. If you’d like help in this regard or have any related questions, you can reach  Joe Orlando, ASA, at 503-925-5510 or jorlando@exitstrategiesgroup.com.

 

Exit Strategies values control and minority ownership interests of private businesses for tax, financial reporting, and strategic purposes. If you’d like help in this regard or have any related questions, you can reach  Joe Orlando, ASA, at 503-925-5510 or jorlando@exitstrategiesgroup.com.