Mark: Welcome to Unsuitable on Rea Radio, the unique financial services and business advisory show that challenges your old school business practices and the traditional business and culture. You’ll hear from industry professionals who think beyond the suit and tie to offer meaningful modern solutions to help you enhance your company’s growth. I’m your host Mark Van Benschoten.
Your business is your most valuable asset but do you really know what it’s worth. If you don’t you could be setting yourself up for a quick shock, one that could significantly alter your plans for the future. We got a real treat for our listeners today. Tim McDaniel, who is a Rea principal and director of our business valuation services as our first repeat guest … it’s impressive Tim … and Tim is known as the business valuation guy in Ohio and Tim asked if he can come back on the show and talk about what’s at stake if you don’t know the true value of your business. Welcome back to Unsuitable Tim.
Tim: Well, thank you for that kind introduction.
Mark: You look surprised.
Tim: I am surprised coming from you.
Mark: Before we get started, value … you know, what’s value and you have to say that my fantasy football team had greater value than yours because I won more money. Would you agree?
Tim: I think I came to the conclusion this year that fantasy football is like playing Powerball. Pure luck because obviously I am a lot smarter, more strategic and all those type of things and I didn’t win any money this year.
Mark: I won quite a bit of money.
Tim: It’s just pure luck and obviously I was sitting here today … I did not win the Powerball.
Mark: That’s the only reason you’re here.
Tim: That’s the only reason I’m here.
Mark: We talk about value and true value and I always think about you heard the stories about the tulip mania, the bulb mania in the Netherlands in the 1600s and how for some reason all of a sudden these bulbs were selling for $10,000 and astronomical prices. What is true value? I mean if I’m willing to pay $10,000 for a tulip bulb for you, is it worth $10,000?
Tim: Well, that’s a great question because I have seen that tulip phenomenon a couple times in my career back in the 1990s … like 1990s when you used to have an internet company that had some revenues that lost a lot of money, they would sell for a multiple revenues. It was crazy and I just didn’t understand how the valuations were going to keep going and then 9/11 happened and everything crashed. Yeah, there is some insanity out there in valuations at times.
The value is simply future cash flow divided by a rate of return and that’s what true value is. We have three different types of buyers out there. You have a financial buyer and somebody like me who would buy a business and I don’t have the synergies to pay you extra, there is a synergistic buyer who can go out there and pay more for your business because they can lay off people and these other strategies involved and then there is the idiot buyer and that’s somebody who just overpays and doesn’t know what they are doing and if you can find an idiot buyer, that’s great.
Mark: I suppose nobody comes in and says, “I’m an idiot buyer.” They’re probably all faked or synergistic.
Tim: Right. I think so.
Mark: … and probably in a few years down the road before they self-label themselves as an idiot buyer.
Tim: That’s correct. Yeah. Usually buyers all believe that they are a lot smarter than the seller and they can do a lot better with the business.
Mark: I agree with that but I struggle that somebody is that full of themselves that they are going to walk in and say, “I can do it better than this person.”
Tim: Yeah and it is very rare that you find somebody who missed values accompanied by significant amount when they are a buyer. In today’s world most people are professional buyers and know what they are doing.
Mark: Getting back to your example of the internet companies and the build up to when 9/11 happened … so you mean like on September 10th a company could have been worth X and then September 12th now it’s worth X minus whatever. What’s the value? I guess on September 10th the value really was what it was trading for or …
Tim: Well, again to me the value is all return on investment.
Mark: … so it sounds to the future you’re kind of making a bet?
Tim: Yeah, you’re making a bet and that’s one reason why it’s really important for a business owner to know their actual value because there are times where values actually increase more than their company’s really worth and that is a good time to sell like right before 9/11 and you just think about the time in 2006 and 2007 before the banking crisis valuations went up significantly then in 2007 all the values crashed and we’re in that similar situation right now. Valuations are really high. They are as high as I’ve seen since 2007 so if you are a business owner thinking about selling, I’d do it now.
Mark: Now is the time.
Tim: Now is the time if you’re thinking about selling the next year or two, why wait because there could be a world event or something happens that would lower values.
Mark: This is a new segment. Predictions by Tim.
Tim: I’m not sure I’m making a prediction here.
Mark: I was just going to ask you, do you had some predictive model here as to what’s going to go on. It’s interesting that you point out like these values come up and then something happens … obviously 9/11 wasn’t anything financial … it was a terrorist attack … but then 2007 was a financial crash and obviously we don’t know if something terrible is going to happen from a terrorist but you never know what could affect your value.
Tim: That’s one reason why you should actually always know your value, have your company ready for sale and again we don’t know what the future is going to be. Maybe things will keep on rising but at some point, the valuations won’t make any sense and I think we’re actually starting to hit that point right now where valuations are starting to come down a little bit right now.
Mark: There is multiple reasons to know the value. It’s not just the buy and the sell side, correct?
Tim: Right.
Mark: Estate planning?
Tim: Yeah. Estate planning is good. I think if you want to gift your company to your kids the best time is when your value is low. You can get more bang for your buck. You know the estate tax right now. If you trigger that, you’re going to be paying 40 cents on the dollar.
Mark: I think you’ve answered my question of struggling of value so September 10th I’m betting that the value of this internet company is going to be worth this because I feel I have some insight as to what internet companies are going to do and then on September 12th, I readjust my thinking is now I was completely wrong two days ago and now the value is going to be here.
Tim: I think we all see that. Most people probably listening to this have bought and sold stocks and then one day their stock drops 50%. Why did it drop 50%? Because the future expectations of that company have decreased and it’s the same with closely-held businesses. 9/11 happens … it’s not necessarily something magical but the future cash flow of most companies went down because the consumers only spending less money and those type of things.
Mark: If I could paraphrase it … I don’t know if that’s the right term but … so closely-held business in central Ohio, their value was affected by September 11th.
Tim: Yes.
Mark: So these things outside of your control affect your future cash flows.
Tim: Absolutely.
Mark: I think people don’t understand that. They think, “I had a great year and I did better so the value of company must have gone up” but the rest of the economy could have gone in the tank and they wouldn’t have seen the results that they thought.
Tim: Yes, and there is also inside factors and also outside factors. Maybe a key employee leaves. We did a valuation of company that had 80% of their business with one customer. That customer quit and the company went bankrupt.
Mark: … so the value was them.
Tim: There is internal factors and then there is external factors that impact value.
Mark: It’s important to know … a business owner to know what their value is and probably why it is.
Tim: Exactly. That’s why it’s really critical to have a business valuation right now because you can see the factors. What drives value and when I do a business valuation I try to forecast the future cash flow of the business but what’s really critical to the business owner is the risk that we develop. The rate of return that an investor wants for your business is it 15%, is it 20%, is it 30%? That depends on how risky your future cash flow is going to be.
One company that had 80% of its revenues with one customer, will you pay him a lot of money upfront?
Mark: No.
Tim: What would you want? You want some type of earn out where you want to make sure that the company is going to be a customer for the next four or five years. Those are good things to know as a business owner right now and then if you’re going to sell in two or three years, you can start fixing these risk things and your value can go up significantly.
Mark: In your example, you could diversify the sales probably. Maybe enter into a long-term agreement with that customer.
Tim: Absolutely.
Mark: Different things that can be done right. What other things could a business owner look at from … like hear what’s going on with my factors that they might be able to employ?
Tim: Well, say you had a key employee maybe you had one great salesperson that brings you 50% of your sales …
Mark: We’ll call him Brad.
Tim: Okay, we’ll call him Brad. Let’s say Brad doesn’t have an employment contract and someday Brad walks and doesn’t look very happy and the competitor calls him up. Half of your business could be gone if he doesn’t have an employment agreement.
Mark: Right so we could put that into place.
Tim: Right, and there is lots of other factors.
Mark: Succession planning?
Tim: Absolutely. That’s critical. If there is a business that has an owner who is 70 years old and has no succession plan, the banks are going to get nervous, somebody who is going to buy the company is going to get nervous, management team is key and one of the biggest drivers of values is to create a nice management team.
Mark: I didn’t know that.
Tim: What buyers are looking for is sustainable cash flow …
Mark: That makes sense.
Tim: … and what makes cash flow sustainable? Good customers, good employees, good product and if you have the world greatest idea, you’re making a ton of money on it, somebody else is going to figure it out so maybe you need to get intellectual property protection and those type of things.
Mark: That kind of sums it up. It makes it very simple. To make sustainable cash flow what’s going to drive that and you don’t have a good management team. Well, you’re at risk. Actually that may be one of your risk factors.
Tim: Absolutely.
Mark: Your employee base is sketchy, that’s going to be one of your risk factors. You make it sound so simple.
Tim: It is simple in theory but the key is properly forecasting the future cash flows. What drives me nuts when I review other valuation reports is people spit something in a computer and they average the last five years and say that’s the future cash flow. We were talking about the future. That’s the past. Is that an indication of the future? It may be.
Mark: May be, might not be.
Tim: Might not be. That’s the real key of a valuation is getting in there and understanding what the future cash flow is and the risk factors. Now there is something else in there. There is the balance sheet. If the company has a billion dollars of cash, it’s going to be worth more than a company that has a billion dollars of debt.
Mark: Makes sense.
Tim: You factor the balance sheet in there also.
Mark: On the cash flow, you’re asking somebody what’s going to happen in the future and obviously the further they go out, the less accurate you’re going to be.
Tim: Right. Like if you have long-term contracts with your customer, man, you’re golden.
Mark: You’re set.
Tim: But it’s hard to do.
Mark: Yeah. Very hard to do. You mentioned the balance sheet and obviously the example of a bunch of cash or a bunch of debt, what other things would impact … on the balance sheet might have an impact on value?
Tim: Well, if you have a lot of good fixed assets that could be sold, you could leverage that in a bank loan and therefore your cost of capital will be lower. Balance sheet is very important. If you have a low working capital or a poor working capital that’s more risky. Again we think risk, we think rate of return.
Mark: On to sustainable cash flow. Greater risk you’re going to want a greater rate of return.
Tim: Absolutely.
Mark: Maybe I should become a business valuation guy.
Tim: I don’t think there is any way you could.
Mark: The learning curve is too steep.
Tim: Well, it’s just … I’m not sure how to explain it.
Mark: We don’t have enough time.
Tim: You are a fantastic auditor.
Mark: Thanks, and I should stay there?
Tim: You should just stay there.
Mark: Thanks for that compliment. Darlene just called me and asked before and now you’re telling me I can’t become a …
Tim: You’re a whole … I’m sorry.
Mark: I thank God I like myself. You say that a business owner or owners … not just people who singly own but a group of owners should know their value annually?
Tim: Well, I’m not sure everybody has to have it annually. I think the prior podcast I did was on buy-sell agreements and that’s probably the worst written agreement most business owners own and I think you should have a valuation maybe every other year just set the value per the buy-sell agreement. But think about this Mark, let’s say you’re counting on your retirement and you have no clue what 70% of your assets are worth. Most business owners, their interest is worth about 70% of their net worth so you are flying blind and my opening chapter of that book I published, we talked about the lady who thought her business is worth 2.5 million. I went and valuated it. It was worth only $700,000.
Mark: It’s big delta.
Tim: Big delta and their retirement plans had to change.
Mark: Can you give us the name of your book again please?
Tim: Know and grow the value of your business: An owners guide to retiring rich.
Mark: It’s a great title. Did you write that yourself?
Tim: I did.
Mark: Oh my goodness. Maybe I was either thinking about when … you said every other year buy-sell agreements but maybe like if you had opened up a new facility and a new location that might cause a reason for a value rise or maybe if you lost a large contract or a large customer, those big events you might say, “I should go get a value because I really want to know how this impacted me.”
Tim: Absolutely. The concept that I really try to preach is treat your business like an investment.
Mark: I’m going to look at the stock page and when I go home at night to see what I did so I should know what the value of my …
Tim: Right, so if your business is an investment, what do you do if an investment … you know it’s value then you make plans to grow its value then at some point you monetize it’s value.
Mark: Convert it to cash.
Tim: Yes, so that’s what you should do with your business and a baseline valuation will help you determine how to grow your value and the clients I love working with are the ones that get a valuation, then I meet with them quarterly and we discuss ways to increase the value or discuss their succession strategies and I think it’s just time worthwhile for the business owner.
Mark: It must be very rewarding.
Tim: It is. We just closed the deal. We did a two-year process with the client and they get tens of millions of dollars in the transaction. It was just a fun day.
Mark: I bet it was and rewarding personally means you start it and you went through this process.
Tim: Right.
Mark: That’s great. How good for you. Congratulations.
Tim: Thanks.
Mark: That’s very exciting stuff. My last question on the valuations is it cost-prohibitive to have evaluations so somebody says, “I can’t afford that.”
Tim: No. I don’t think so. I think it’s actually … it’s going to cost you a lot more not having one.
Mark: Great point. You’re going to give up a lot.
Tim: Right. We have various levels of valuations. We have the 80-page report valuation that goes to the IRS if you make a major gift but we’ve developed … I call it …we used to call it a snapshot valuations, I call it now a strategic valuation where it’s more in a summary form but actually does a lot of valuation calculations and gives the correct value and we use it for business planning purposes. You use it for your buy-sell agreement.
Mark: Give you that benchmark on here is where we’re starting at.
Tim: Right. That’s a lot less than doing a full report.
Mark: Sounds like it would meet the needs.
Tim: Yes.
Mark: I don’t know if you remember from my … your first time here we ask all of our guests a certain question and if you could have one superpower, what would it be?
Tim: I’m not going to use the same one. I could say go back and guess the future and get the Powerball numbers …
Mark: There you go.
Tim: That may be a good one but actually I’m ready to give that all up if the Cleveland Browns or the Cleveland Indians can win a championship in 2016.
Mark: You are asking a lot.
Tim: I am asking a lot. I am.
Mark: I hope it works out for you. You might have a greater chance with the Powerball.
Tim: Probably right.
Mark: Thanks for coming back to show Tim. Listeners, when was the last time you calculated the value of your business? It’s been a while email us at podcast@reacpa.com and we’ll introduce you to Tim. Don’t forget to check out our website, www.reacpa.com/podcast. For more information about this episode, show archives, additional resources and more. If you haven’t already, please subscribe to Unsuitable on Rea Radio on itunes or on SoundCloud. Until next time, I’m Mark Van Benschoten for Unsuitable on Rea Radio encouraging you to loosen your tie and think outside the box.
