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Business Valuation in the Current Declining Market
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Business Valuation in the Current Declining Market


By Jerry Barney Wednesday, April 29, 2009

It likely does not come as a surprise that business valuations have dropped dramatically since October 2008.  Many owners are wondering how to assess their current value and how to plan for the future.  Here are some current trend observations by American ValueMetrics Corp, which is a national business appraiser.  Please remember that these are broad trends, like the tide, and that individual transactions may be waves upon the tide, either significantly higher or lower because the markets are currently very volatile.

The Size Premium has Disappeared. This phenomenon arose with the growth of private equity funds which were willing to pay a premium for small business acquisitions based upon easy credit with banks.    Prior to the collapse, the typical multiplier of price/EBITDA  on $1MM EBITDA was 7 to 8 X, where at about $200K EBITDA the multiplier was about 3.5 to 4.5 X.   The size premium is now gone, and the trend for larger small businesses is to sell at the same multiplier as the smaller ones. ((Note: EBITDA = Earnings Before Interest, Taxes (Income) Depreciation and Amortization))

Price/EBITDA Multipliers themselves have Decreased. The multiplier for businesses in general has dropped by about 23% since October, 2008, -- meaning that the basic multipliers are now tending to range form 2.7  to 3.5 X EBITDA.  This is likely due principally to the difficulty in financing acquisitions.

Demographic Trend. The outlook for the next 10-15 years is not promising.  Aside from the turbulence caused by political and regulatory policies, there is an underlying demographic trend that is inescapable.  The “baby boomer” generation has now reached the retirement age range – meaning that their propensity to consume is declining.  And they account for about 70 million Americans.   Economist Harry Dent (see www.hsdent.com) has studied this trend.  His research shows that the proclivity for maximum consumption occurs at about age 45-50.  This age cohort is in steep decline as the boomers enter their retirement years.  This trend alone will likely generate a “permanent” decline of 25-30% in consumer sales over the next ten years or so until the echo-boom generation picks up a little speed.

Coming Decline in Consumer Spending. Easy credit is gone, and the personal net worth of those with real estate and securities investments has been roughly halved from its peak.  Institutional borrowing is no longer a viable way to spend money you don’t have.  So not only will there be fewer consumers in the coming years, they will have less buying power.

Increasing Job Losses. Actual people employed is currently declining by a staggering 8 million a year or more.  It is expected to do so until the excess capacity of business is absorbed.  This could take two or more years.

So What Should Business Owners Do? First of all, for those who are able to do so, eliminate leverage (debt) to the extent possible.  Renegotiate everything you can – leases, vendor agreements, terms, etc.   For those with cash it will be a lifetime opportunity to acquire weak over leveraged companies at distressed prices, and increase market share.  Consolidations to increase efficiency and reach higher economies of scale will be beneficial.  Remember, even with a decline in sales, of maybe 40%, there will still be 60% of business available.  Companies which can survive will inherit these customers.  The “Last Man Standing” strategy will likely be successful.  More than ever, those who can provide goods and services at the lowest prices will be more successful.

Those who cannot escape their over leveraged position, and cannot sustain a positive cash flow, must redouble their efforts to reduce overhead or increase sales, or face bankruptcy.  It is a good time to consider some assistance from qualified consultants to explore merger or consolidation possibilities.

For those who want a successful sale, it will be necessary to cure defects that would diminish marketability.  Two of the common ones are lack of a management team (all executive control in the hands of the owner), and a poor marketing program.  It is not essential to hire staff to perform these functions in house – it can be done quite cost effectively by contractors.  Businesses that can be owned semi-passively, sell much better than those that don’t.

But remember, that the economy will not totally disappear, it will merely shrink.  There will still be people buying luxury items, just not so many of them.  Well-managed, low-leverage, companies will compete for this market.

More By Jerry Barney

 

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