Finding Value In a Business When Cash Flow Is Negative

By Jerry Barney Tuesday, September 8, 2009

Can a company have a negative cash flow and still have goodwill value?

The answer, maybe surprisingly, is YES!

There are three elements that create Going-Concern or Goodwill Value. Not all three need to be present to create the value.

  1. Assets in place and ready to use as a going-concern (capital, labor and management)
  2. Excess economic income over that justifiably allocated to other assets
  3. Expectation of a valuable future event, such as gains on a sale

An appraiser must assess all of the attributes of a business to determine if items one and three on the list above pertain.

A company’s cash flow is the key to its value – greater cash flow begets not only greater value, but it fetches a higher “premium”, or multiple of revenue or cash flow, as the size of the cash flow increases. But, what if the cash flow is negative? All is not necessarily lost; there may be value to be found even when times are difficult.

During difficult econominc times and recessions, cash flows for many companies suffer. When looking for opportunities to sell your business, or merge with or acquire another business, you may look beyond the cash flow to find its real value.

Tangible Assets are the first place to find value. Your equipment, furnishings, vehicles, etc. all have some value depending on their age and condition. The tangible assets typically will sell for their market value without much of a premium (although in some cases they have greater value if sold as a functioning set, rather than sold off as individual items). Intangible assets that may be transferred (called discrete intangibles), such as franchise fees and licenses, also carry value.

Next, look for other intangible value; that is, value beyond the tangible and discrete intangible assets of the company based on what they add to company performance.

Here are some common sources of intangible value:

  • Location and Facilities of the business: Excellent location and leases with favorable terms that can be transferred may add intangible value.
  • Customer List: For businesses with a great deal of repeat business from its clients, the database of clients certainly has value.
  • Proprietary Processes: Businesses whose success is partly due to proprietary processes, technology, or methods, have value in those processes or technologies. These processes should be documented in such a way as to be transferable and repeatable by a new owner.
  • Patents and Copyrights: Patents and copyrights for useful, saleable products or information add to the value of the company, as long as they belong to the company and not the owner.
  • Personal Goodwill: If a significant proportion of the company’s success is related to the owner’s knowledge, skills, personality, reputation, etc., that is called “Personal Goodwill”. This means there is significant risk to the business if the owner leaves the company (and the value leaves with the owner). Some ways to keep the value with the company and not the owner personally are to sign a non-compete agreement and to transfer the Personal Goodwill to Institutional Goodwill. This transfer happens through training remaining employees, formalizing agreements into contracts, and staying with the company after it is sold for an agreed period of time in order to train the new owner.
  • Certifications, Best of Breed: Certifications and recognitions of the company as a valued supplier or “best in breed” will also likely add to the value of the company. Oftentimes, communities have publications of certified suppliers, and to be included requires an application process.

In general, anything that can be done to formalize the advantages of a company into something that is transferable and repeatable should increase the Intangible Asset value.

Also, information can be determined for sales comparisons of companies with significant negative cash flows which still sell at a premium over hard asset value. This is common, for instance, in health care facilities, where the entity has significant value in licenses, certifications and entitlements, which create an expensive replacement value component, which is not discrete – that is it cannot be detached from the business and sold, and therefore contributes to non-discrete intangible asset value, or “goodwill”. A professional business appraiser can assist in determining that value, and a broker can help you market all the advantages your company has to offer.

*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.

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