Buyer Cash Flow / SA
On-Line Newsletter
Dec 1999

brought to you by Business Resource Associates, Scottsdale, AZ

This newsletter brings to interested business brokers, financial intermediaries, buyers and sellers important updates, news items, user comments and suggested deal structures for actual businesses for sale. Please feel free to send us comments and questions of a general nature and concern for all users of BCF/SA.

The value or price of a business?
The "Done-Deal Zone"
Case study #3: Manufacturing firm

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The value or price of a business?

In the Nov issue we spoke of the value of a business as determined by the standard business valuation techniques and programs. We said:

"The buyer wants cash flow to him either as a dollar amount or a percentage return. The seller wants the best possible price under this requirement of cash flow. And this view will usually alter the value, as determined by the valuation programs, to the price actually paid by a buyer . . . We see the value of a business not as some intrinsic value somehow attached to a thing called a business, like the appraisal value of a house. We see the value as the price paid by a buyer to a seller, each of whom is not acting under duress."

Valuation methods stop at the valuation price and pay little attention to the terms and conditions of the pending sale (except for the SDC method which allocates a debt service estimate and a return to the buyer in arriving at a price for the business). Some programs offer a buyer cash flow statement as "a justification for purchase", but this is after the fact. It does, however, allow you to "tamper" with the valuation figure to adjust the price to some acceptable or reasonable sale price.

BCF/SA has been designed to add flexiblity to the cash flow scenarios offered by several business valuation software programs. We treat the valuation figure as a starting point just as the sale price wanted by your seller. We provide indicators to keep the deal structure to within accpetable limits (see next article below for more information) -- Buyer IRR, Biz IRR and P/E. Also provided is an estimate of the business value as seen by both the buyer and seller --and you know they are not the same value - Seller val and Buyer val. These values are determined by limiting the Biz IRR figure, outside of which there is only a 16% chance of a successful deal. The Seller will use the lower IRR to produce a higher price and the Buyer just the opposite -- the higher IRR to get a lower price. The deal should close with a price within this range.

In the article Valuing Versus Pricing, in the Nov 1999 issue of "The BusinessBroker" newsletter, it states:

"Pricing is simply an attempt to arrive at a price that the 'market' might pay for the business . . . it is an approximation of what the business might bring in the marketplace."

The BCF/SA program will help you arrive at a price and terms acceptable to the "'marketplace"

Is your business within the "Done-Deal Zone"?

Done-Deal Zone? "What's that?" you say. Let me clarify by first saying that it's not an automatic done-deal zone. BCF/SA looks only at the financial aspects of a deal and we all know that there are other factors that make-break a sale. Some of your "solid" busineses don't sell and some of your "losers" do. Even within our financial research we can only say there is a 16% chance of not doing the deal. Otherwise, it should be a Done-Deal.

Look at the chart shown below. Let's assume that business category produced a Biz IRR of 52% (or a P/E of 2.6 at the center of the middle line). The "triangle" above this position on the upper line represents the Buyers view and the "diamond" on the lower line represents the Seller's view. This is the "Done-Deal Zone". Negotiating and compromising will bring the Buyer IRR within this range for a successful sale.

Take a look at the chart again. If you draw a line from the "triangle" to the left where it hits the middle line, this is the "equivalent" P/E as seen by the Buyer -- it is just over 2.1 meaning he "sees" a price, just a little over 2 times the income and not 2.6 times the income. He wants the Buyer IRR to be above the middle line. Guess what the Seller sees? This time run the line from the "diamond" to the right to the middle line. The Seller is "looking" at a a higher price which is a 3.2 P/E or price 3.2 times the income. He wants the Buyer IRR to be below the middle line. We are using the Biz IRR for this chart since it is this data that shows us the financial conditions for selling this category of businesses..

If a new Buyer IRR is obtained by adjusting the financial terms we can repeat the above analysis all over again. Whether the new P/E is 2.8 or 2.3 you can repeat the analysis over and over until a deal is made. If the new P/E is outside the range, say 3.4, you would be in "never-never land". It is important to note that you are adjusting the terms and conditions, except the income (unless it is re-stated after due diligence), to arrive at a Buyer IRR acceptable to both parties..

As stated earlier, the financial aspects of a sale are not the only factors in a successful deal. But, if you can eliminate the differences over the financial terms -- price, down and note payments -- you can concentrate on the other factors that may be holding up the close. These "other factors" are only important, in many deals, because the deal has already been accepted on the financial grounds. Otherwise, why bother with a landlord or arguing about the type and length of the training. You heard this before: "If we got a deal we can work this out".

case #1 manufacturing firm

The above table shows the results of 2 financial analyses for a manufacturing business. The listing "Buyer IRR" value falls outside the 'target' range for "done deals" which would be, in this case, 56% - 36.0%. It has a P/E of 4.3, which is very high, giving rise to the 17.4% IRR. However, the Biz IRR shows a 46% normally expected return for a manufacturing business. Comparing the Buyer and Biz IRRs, we see that this financing structure results in a IRR far below the limit for an acceptable sale, which we've found to be at the 36% level (46.-10). An "acceptable" sale is one that has over an 80% chance of succeeding, based on our research. It looks like this will be a very hard sell.

The second analysis reveals how BCF/SA can improve the deal structure. The financing structure indicates a Buyer IRR of 36.4%, just within the BCF/SA criteria limit. In order to accomplish this, the price was dropped to $200,000 with $125,000 down. While the Seller may not be too happy, the business has been "put into play" with these terms and conditions. It now has a chance of being sold.

Not shown are the flags indicating a debt payment exceeding 33% of the income. Also not shown is the BCF/SA calculated "Seller val" of $191,000 which is lower than the selling price of $200,000. It suggests that the Seller is still geting a good deal.

From a financial perspective, this business is still a "hard sell" even after making the above changes to the deal structure.

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