Here are some of the other findings:

* 80% of business fraud is committed by someone in one of the following departments:  accounting, operations, sales, executive/upper management, customer service, or purchasing

*  In 43% of fraud cases the perpetrator was living beyond their means

*  In 36% of fraud cases the perpetrator exhibited signs that they were experiencing financial difficulties

*  Small organizations are disproportionately victimized by occupational fraud.  These organizations are typically lacking in anti-fraud controls compared to their larger counterparts, which makes them particularly vulnerable to fraud.

Here’s a link to the entire ACFE 2010 Global Fraud Study:  http://www.acfe.com/rttn/rttn-2010.pdf

BNet featured a series of 8 drawings that correspond to steps to sell a business that is worth checking out:

The Art of Selling A Business

I do have a few comments, though, about a few of the steps:

1.  The author’s first step is to “Get real about what your business is worth.”  While I agree with the author that a business owner should definitely develop an understanding of what their business is likely worth, the tip of “Buy lunch for a mergers and acquisitions professional or business broker and ask them for a guesstimate of what a business like yours is fetching these days” is NOT a good idea.  Here’s why:  there are many issues that could have a significant impact on your business’ value.  A casual conversation over lunch with a M&A advisor or business broker won’t provide a very accurate estimate of value, and may result in a “guesstimate” that is dramatically higher or lower than what your business is realistically worth.  Instead I would suggest hiring the business broker or M&A advisor to do a thorough review and valuation of your business. This review should be far more than simply looking at the past two year’s financials and making some quick calculations and applying a multiplier to it.  The business broker or M&A advisor should develop a strong understanding of your business, including, amongst other things:  the business model; risk factors; differentiators between you and your competitors; business strengths; the overall competitive environment; opportunities for growth; historic and probable future growth; trend analysis; ratio analysis; diversification of revenue by product and service; intellectual property; the quality, breadth, depth, and retention of staff; and threats to the business’ long-term success.  Without knowing these types of things, an estimate of value will be little more than a guess.

The cost of this can vary dramatically depending on the advisor, the scope of their review, and the complexity of the business.  Most businesses with under $20 million in revenue should expect to pay between $3,000 and $20,000 for this type of review, and (if planning for a future sale a few years in advance) annual updates can be done for a lower price.  My company, Codiligent, charges a flat fee of $3,500 for such a review for 90%+ of businesses (the remaining 10% may be more involved and thus cost more).  Furthermore, if an analysis client turns into a business sale client in a relatively short period of time (or longer period if the client does annual updates to the analysis) then Codiligent will credit a large portion of that analysis to any closing commission earned.  I believe that most business owners will find that this is money well-spent:  you’ll not only have a much more accurate idea of what your business may sell for, but you’ll also have a better understanding of issues that may negatively impact value and marketability.  If that information results in you making changes to the business and then selling a couple of years from now and those changes result in price that is even just a couple of percentage points higher, it may pay off handsomely.

2.  Another point that the author makes is that if you can “Disappear for a While” and the business operates fine without you being present, then it is a good indication that the business can be successfully transferred to a buyer, and thus will be more marketable.  This is great advice.  If you find that your business doesn’t run well when you are gone, then it is probably time to work more on your business’ systems before selling.  A few books I’d recommend related to systems include Sam Carpenter’s “Work The System”, Michael Gerber’s “E-Myth”, James Womak’s “Lean Thinking”, and Jeffrey Liker’s “The Toyota Way.”

3.  In the author’s step 5, which is “know when you lose your leverage” he points out that a no-shop clause in a Letter of Intent (LOI), while usually necessary, will take away some negotiating power, and his tip is “Expect the offer price to drop by 10-20 percent after you sign the LOI and be pleasantly surprised if it doesn’t.”  While I don’t disagree with the author’s premise, did you know that Codiligent’s business seller clients, on average, have experienced less than a 1% price renegotiation between LOI and closing? I believe that one of the reasons my firm is so successful in maintaining prices is that we approach business sales differently than most brokers and intermediaries.  Most business sale intermediaries, unfortunately, do a poor job of packaging the business, which means that a business buyer will still need to do significant discovery of material facts as part of the due diligence process, rather than primarily being about verifying material representations already made.  Adverse findings during due diligence often results in either a lower price being negotiated or, even worse, an aborted deal.  In contrast, Codiligent provides a far more comprehensive confidential information package which includes most of the material disclosures necessary for a buyer to make an informed buying decision BEFORE a LOI is signed.  That doesn’t mean that we will necessarily give out ALL confidential information in the package prior to due diligence.  For example, we may promote that a business has some excellent clients, but we don’t necessarily have to reveal their names.  Instead of naming the company’s top client, XYZ Company, we instead may say something like “The top client, which accounts for 8% of this business’ overall sales, is a privately-held, $200 million+ in revenue business in the food and beverage industry located in the western US.”

In any event, the author of the BNET article’s other points are good ones, and you may enjoy the art that accompanies them.

Codiligent believes that relying solely on such a simple approach to value is problematic  for a variety of reasons, which is why Codiligent conducts a thorough analysis of each business it represents and takes a more comprehensive approach to valuation.  Let me share just one variable that can make a market comparable approach or rule of thumb highly inaccurate:  growth rate.

Using the fictional widget manufacturing sold comparables mentioned above, if the average sold comparable business growth rate was 8%, but Company A, which is being valued, had 20% average annual growth for the past 3 years, and was projected to have a similar level of growth for the next 2-4 years, then using the same multiplier would significantly undervalue Company A.  If we assume average annual EBITDA for both the sold business comparables and for Company A was $280,000, then three years from now the sold comparable businesses would likely have $352,719 in EBITDA, but Company A with the higher growth rate would have $483,840 in EBITDA.  If you paid the same multiple of EBITDA for both businesses, you would have significantly underpaid for Company A for the financial benefits received, or another way to look at this is that three years from now the sold comparables would be producing an EBITDA return on investment of only 35.3% compared to Company A’s 48.4%.

So how can you estimate the impact of growth rate on value?  Codiligent would suggest using a Discounted Cash Flow Approach to Value rather than a market comparable approach.  The market comparable approach may be fine for estimating value of stable, average growth rate businesses, without unusual risk factors, in relatively homogeneous industries, but it does a poor job of estimating the impact of higher or lower than average growth rates, varying levels of capital expenditures necessary to fuel growth, and unique risk factors.

Following are a few scenarios to demonstrate how differing growth rates can impact business value.

The following assumptions were used:

1. At the beginning of the projections each business is assumed to have had annual Seller Discretionary Earnings (SDE) of $200,000.
2. Each business is assumed to have a primary owner salary of $100,000 which will increase by 3% each year.
3. If the annual growth rate exceeds 25%, then capital expenditures are assumed to be 25% of EBITDA, if annual growth is between 16% and 25% then capital expenditures are assumed to be 15% of EBITDA, and for annual growth rates of 15% or less capital expenditures are 7% of EBITDA.
4. Taxes were estimated to be 30% of EBITDA.  I recognize that this is simplistic and may not fully capture differences in profitability and actual tax rates, but 30% was used for the sake of simplicity.
5. The discount rate, long-term growth rate, and cap rate were assumed to be consistent in each scenario.
6. Years 2-5 have a growth rate that is 75% of the prior year’s growth rate, but in no event will the growth rate be less than the estimated long-term growth rate.
7. OFCF stands for Operating Free Cash Flow.  OFCF is EBITDA less taxes, capital expenditures, and normally also reflects changes in working capital but for purposes of these illustrations we will assume that there isn’t a net change in working capital.
8. Terminal Value is calculated by taking the final year’s OFCF times 1 plus the constant rate of long-term growth divided by the capitalization rate. That terminal value is the estimated value at end of year five, and is discounted back to a present value (PV) using the discount rate.
9. Total Value is the combination of the present value of OFCF’s for years 1-5 plus the present value of the terminal value.

Scenario 1

Year 1 Growth Rate is 10%.  The estimated value is $566,671, which equates to 2.83x SDE and 5.51x EBITDA.

Scenario 2

Year 1 Growth Rate is 5%.  The estimated value is $467,606, which equates to 2.34x SDE and 4.54x EBITDA.

Scenario 3

Year 1 Growth Rate is 25%.  The estimated value is $953,047, which equates to 4.77x SDE and 9.26x EBITDA.

An entrepreneur who had a business with a 25% growth rate, but sold the business with a business broker who relied solely on a simplistic market comparable approach in an industry with an average 10% growth rate, may have left money on the table, with that business broker likely having trouble asking for and defending a price above $566,671.   A business broker who instead relied on a discounted cash flow approach that models the impact of likely growth, may have been able to achieve a price that was closer to $953,047 (68% higher).

It is Codiligent’s goal to deliver far more value to its clients than the commission it charges.  There are a variety of ways that Codiligent delivers this value including:  a more efficient process, fewer time-wasting meetings with inappropriate buyers (due to better screening), fewer deals renegotiated after due diligence, greater probability of a deal surviving from Letter of Intent to closing,  far lower levels of seller financing, and better prices and terms.

Last week, I was contacted by a prospective business buyer who was suggesting that a business I was representing was over-priced.  His reason for thinking so?  Another broker who has represented other businesses in that particular industry provided him with data on a variety of sold comparable businesses and told him that businesses in that industry sell for 10-12x monthly revenue.  The sold comparable data certainly seemed to support this contention.

Here’s the problem with this, though:  revenue has very little to do with what something should be worth.  Rather, cash flow is what creates value.  Let me explain why:

A comparable business that sold for $4,166,667 may have had $5 million in revenue.  If the average business in that industry has EBITDA margins that are 11%, then it may have had $550,000 in EBITDA.  If, as the buyer who contacted me suggested, an appropriate price was 10x monthly revenue ($5 million / 12 months X 10 months) then as previously mentioned, the value may have been $4,166,667.  The $550,000 in EBITDA would represent a 13.2% EBITDA return on investment in the first year.

Yet, what if another business in the industry also had $550,000 in EBITDA, but it was a far more efficiently operated business and as a result its EBITDA margins, at 25%, are far higher than average, then it would have only $2.2 million in annual revenue.  If you used this buyer and his advisor’s formula of 10x monthly revenue for value, it would suggest a value of only $1,833,333.  The $550,000 in EBITDA would represent a 30% EBITDA return on investment in the first year.

Since the industry average EBITDA return on investment was only 13.2%, why would a buyer expect to achieve a much higher EBITDA return on investment of 30% for a company that is better operated and thus more profitable?  Logically, the company with the higher margins should be valued higher, all other things being equal, not lower than the poorer performing comparable businesses.

A better way of comparing businesses is to look at a multiple of EBITDA (after paying an owner/manager a market rate of compensation).  In my example above, the average business that had $550,000 in EBITDA, 11% EBITDA margins, annual revenue of $5 million, and a price of $4,166,667 would have sold for 7.58x EBITDA.  If you apply that same EBITDA multiplier to the latter business that also had $550,000 in EBITDA, 25% EBITDA margins, and annual revenue of $2.2 million, it would result in an estimate of value closer to $4,169,000. This would mean that the EBITDA return on investment for the single business with higher margins would be consistent with the comparable sold businesses:  both would have EBITDA returns on investment of approximately  13.2%.

The following Ma & Pa Kettle video reminds me of some deal structure negotiations I’ve been involved with:

Unfortunately, there are flaws with this “no asking price” business broker rationale:

1, Buyers naturally tend to justify why something should sell for less, not more, just as Sellers naturally tend to justify why something should sell for more.  The act of a buyer having to figure out what to offer and developing the rationalization for a lower price will help to solidify a buyer’s belief of the lower price, and absent compelling business valuation methodology that demonstrates a higher price, chance are the final price will be lower than if a realistic price was established and promoted up front.

2.  The market for small businesses isn’t an efficient market.  Each business is unique, there are a limited number of buyers and sellers, there are a limited number of business sales, there’s a low level of liquidity for a small business (you can’t decide to sell now and ten minutes later sell the business for cash as you would be able to do with liquid securities of publicly traded companies), and there isn’t complete and accurate publicly available information on the company being sold or other similar businesses that have sold or are being sold.  Consequently, the inefficient small business “market” may not accurately price what is being sold.

3.  Many prospective buyers won’t participate in evaluating a “no asking price” business.  Many motivated buyers will ignore advertisements and marketing materials for businesses absent a stated asking price.

I suspect that there are more self-interested reasons that cause some business brokers to promote a “no asking price” strategy:

1.  They don’t risk not getting a listing if a seller’s price expectations are higher than they believe they will be able to achieve.  If a seller believes that their business is worth 8x EBITDA, and the business broker believes the business is likely worth closer to 3x EBITDA, it avoids having the business owner seek another business broker who has a valuation expectation closer to their own.

2.  Business brokers are paid on commission and only get paid if the business sells.  Consequently, many business brokers would rather leave some money on the table but increase their likelihood of getting the deal done, then to achieve the best possible price and terms for their client.

3.  It requires less up-front work and business valuation knowledge from the business broker.  When Codiligent business brokers analyze a business there is a significant amount of time and thought that goes into evaluating the business and looking at multiple approaches to value.  In contrast, a “no asking price” strategy doesn’t require the business broker to do any evaluation or possess any knowledge or expertise about business valuation.

Generally speaking, I believe that most sellers will achieve a better outcome by utilizing a stated asking price based on expert advice from a knowledgeable business broker or business appraiser.  However, there are a few circumstances when, in fact, a “no asking price” strategy may be more effective:

1.  The business is distressed and is cash flow negative.  A distressed business will likely struggle to attract significant buyer interest, and valuation will be subjective and/or based primarily on the value and marketability of the business’ discrete assets.  Consequently, a “no asking price” strategy may generate more interest and may even result in a higher price than anticipated.

2.  A business with less than a two-year operating history.  For many profitable businesses that have less than a two-year operating history, the first year or two often have poorer financial performance than they will experience in the future.  Traditional valuation techniques may value such a business lower than what a buyer would pay who sees strong potential growth and profitability based on early stage trends.

3.  A business that has a very rapid growth rate and potential for significant scalability in a large or fast-growing industry, particularly in a hot economy.  For example, a business may have had $1 million of cash flow last year, and had 100% growth for each of the prior two years.  Perhaps there was an indication that it likely could have grown at a much more quickly if it would have had more access to capital.  So, what is the appropriate way to value such a business?  It can’t be based on past financial performance since this would significantly under-value the business.  Projecting 100% growth next year may be too low particularly if the buyer brings access to more expansion capital or marketing synergies.  What type of growth rate can be realistically projected in year 2 post acquisition?  What about year 5?  A seller who has a business like this may find strong competition amongst buyers and a much higher price than many business appraisers using traditional valuation techniques would come up with.

Here’s a link to the parable:  The Old Man and The Tree

I think that one of the takeaways is that there are a variety of ways of looking at value.  Some are far more simplistic than others, and not every valuation technique is appropriate for every type of business.  Still, as a business broker I see some strange price and value rationalizations.  While many business sellers, buyers, CPAs, and business brokers like using a rule-of-thumb multiplier or market comparable approach for its ease and simplicity, I believe that often this is not a very accurate approach to business value.  So, instead Codiligent tends to focus far more heavily on a capitalized earnings approach or discounted cash flow approach in estimating value.

So, if you are planning on holding your business for several years, then these tax avoidance strategies may provide some significant financial benefit, but if you are thinking of selling in the next few years you may want to talk with your business broker to discuss how taking advantage of tax avoidance strategies may impact business valuation.

Here are a few of the reasons why this is a bad practice:

1.  You want your business broker to become intimately familiar with your business so that they can effectively sell it.  If a business broker does a comprehensive review of the business they will develop a far more intimate and comprehensive knowledge of the business which will allow them to more effectively promote your business, confidently answer buyer questions, and respond to objections.  A business broker who is provided with only limited information and/or who doesn’t do a complete review of the business is unable to represent you as effectively.

2.  There are a variety of issues that could impact value and marketability that may not be discernible by simply reviewing the past two years tax returns.  For example:  Are there proprietary systems or other types of intellectual property that give the business a significant competitive advantage?  Is there a high concentration of revenue from a few key clients where if one were lost it would have a disproportionate impact on the business?  Are there any key contracts that are expiring?  Are there any outstanding claims or legal issues that may cause the business to alter its policies and procedures or systems in the future?

3.  Doing a comprehensive review of the business helps in establishing a defensible, realistic value and an appropriate pricing strategy.  A simplistic multiplier approach or rule-of-thumb for valuation based on limited information may significantly under-value or over-value a business.

4.  Any serious buyer who considers moving forward with an acquisition of the business will insist on reviewing far more information prior to buying the business.  Consequently, you will have to provide the information eventually, anyway, so why not take the time to do it right by providing complete information up front?

5.  A large part of having a business sale succeed is in establishing the buyer’s confidence in the business and reducing uncertainty.  Providing solid, complete information without delay decreases buyer uncertainty and increases confidence.  Contrast this to a buyer asking a broker a question that requires information from the business owner.  Perhaps the business buyer emails the question to the broker on Thursday morning, but the broker doesn’t get it until Thursday afternoon due to being in a meeting with another client.  The business broker doesn’t have the information requested so he contacts the seller.  The seller then says he will have to get the information from his CFO.  The business broker reports back to the buyer that he should have the information within the next couple of days.  However, unbeknownst to the broker the CFO is traveling until Tuesday.  On Friday the broker still hasn’t heard anything back, so he calls the business owner but only gets voice mail and doesn’t hear anything back, since the business owner knows his CFO will deal with it when he is back in the office.  On Tuesday the CFO gets back, but is buried after being gone for a couple of days and doesn’t get the information back to the business broker until the following Thursday.  So a week has gone by.  What’s going through the buyer’s mind?  ”Gee, I thought I made a pretty simple request for information.  Why is it taking so long to get it?  Are they serious about selling?  Are they disorganized?  Is there a problem with the information I requested that they are trying to fix?  Maybe I should give more attention to another business I was considering.”

6.  You run a greater risk that the price and terms will be re-negotiated as a result of due diligence, or worse – that the deal will die.   If a buyer makes an offer based on incomplete material disclosure and then during due diligence discovers new information, there’s a good chance that they will use it to negotiate a lower price than they originally offered, or, if the information is significant enough, they may back out of the deal.  This is problematic for another reason:  most Letters of Intent call for an exclusivity period for the buyer from the time the Letter of Intent is signed until they complete due diligence (often a 2-4 week period).  This means that active marketing and communication with other buyers must cease during this time frame, so in essence the business is off the market for 2-4 weeks.

Codiligent strives to do everything possible to increase the probability of attracting the right buyers, getting them to complete a transaction, and pay the best possible price and terms.  As a result, the business selling process is necessarily front loaded with information requests, analysis, packaging of the business, and researching logical buyers.  This is often one of the most important transactions of a business owner’s life, and it deserves to be handled as such.  Yet, just because the process is comprehensive doesn’t mean it will take significantly longer than if handled by a broker who fails to do a similar up-front process (and in the long run it will save time).  Codiligent has developed a proprietary process and methodology that makes the collection, analysis, and packaging of the business VERY efficient.  It is not uncommon for a 60+ page analysis, initial information package, and a 100+ page confidential information package to be developed within 1-2 weeks.