The 7 basic principles of business valuation : Principle 6Jean-Claude Desnoyers
Principle nº 6 : Value is influenced by liquidity.
The value of a business is influenced by its liquidity. Liquidity can refer to two concepts:
- How easy it is to sell a business and
- Liquidity of the assets in the business.
In both cases, we refer to how easy it is to convert an asset into cash. In this article, we will discuss how easy, or not, it is to sell a business and the impact of this on its value.
The liquidity of a business versus another
The more liquid a business is, the higher the value. The concept of value being influenced by the liquidity of the business may seem a bit fuzzy at first, but it is, mostly, quite simple. Can the business interest several buyers and is there an organized or semi-organized market?
In fact, when a Chartered Business Valuator (CBV) is trying to measure the liquidity of the business, he or she may think of, among other things, about the following:
- The industry in which the business operates;
- If the business is a public company or private ;
- The size of the business;
- The organization of the market of potential buyers and the presence of specialized intermediary;
- Whether or not, there are strategic buyers already identified;
- Whether or not there are buyers working to consolidate the market;
- Whether the type of business fits easily into an existing business or not.
The industry in which the business operates
Take the example of two private sector companies. Company A owns a restaurant downtown. Company B is a professional firm offering a highly specialized service. Which of the companies is the most liquid? In practice, probably the restaurant, because there are more potential buyers. One of the indicators I use in practice for measuring liquidity is the number of transactions in that industry in a transactional database. If there are more registrations for one type of business than another, then, all things being equal, the first business is probably more liquid.
Is the business a public company or private?
A public company is a publicly traded company. If you own shares of a publicly traded company and you want to sell, you just have to call a broker and you can sell your shares. In the case of a private company, to be able to sell, you have to find a buyer.
The size of the business
The bigger the business, measured for example, in terms of earnings before interest, income taxes, and depreciation (EBITDA), the more interested buyers there will be. In practice, there seem to be many more potential buyers for a business with an EBITDA of over $ 500,000 than smaller ones. There are more intermediaries working in this market and there are more buyers, including institutional buyers.
The organization of the market of potential buyers and the presence of specialized intermediaries.
If we are in a market, let’s say dental offices where there are specialized brokers that make it easier for sellers and buyers to get in touch, then the business will be more liquid than in another market where there are no specialized intermediaries.
Are there strategic buyers already identified?
A strategic buyer is a buyer who may have post-acquisition benefits to acquire the appraised business. These benefits can come, for example, from additional sales that the business could realize by selling to the customers of the purchased business, or from the reduction of costs related to an economy of scale. This type of buyer can offer more for the business than its intrinsic value, especially if there is competition with at least one other strategic buyer for the acquisition.
Are there buyers working to consolidate the market?
If, for whatever reason, the business is in an industry where one or more buyers are buying in order to consolidate the market, the business will be more liquid. For example, there was the funeral homes industry some years ago and retirement homes.
Does the business fit easily into an existing business?
For example, one may think of a client of an insurance broker or an accounting office. In both cases, if the buyer has excess production or service capacity, he or she could take over the purchased business’ customers and reduce the operating costs. There could also be savings in terms of rent, insurance, phone systems, etc. Usually, the more a business can easily fit into another, the more liquid it is.
Find a business on the market
Did you know that in the private sector, it often takes a minimum of six months to sell a business? And not all businesses are sold. The presence of intermediaries in the target market favors the sharing of information related to potential deals. I am thinking here of groups of professionals such as the M & A Club where professionals discuss business opportunities for their clients. You can learn more about the M&A Club by reading my post on the subject. Are you planning to sell your business and would like to know the value? Would you like to know more about the concept of liquidity and where is your business in the market?
Contact me today. I will be happy to help you!