Selling When Business Valuations Are Low

Selling When Business Valuations Are Low

By DIANA RANSOM

Investors weren't the only losers when the stock market crashed last September. Business owners also watched their company valuations plummet.

Timothy Butler, the president and chief executive of Tego, an RFID chip maker in Waltham, Mass., saw his firm's value fall quickly with the market's downturn. Moreover, the recession spooked venture investors. Before the crash, Butler had expected to land investment funds in the range of $1.5 million to $2 million. Instead, he says his firm wound up with just a third of that amount in its coffers.

"It was a very difficult time," Butler says. "We reduced salaries temporarily. We had to cut certain projects and renegotiate the timing and paying of creditors. And we had to rewrite our business plan to recognize current realities."

Many firms turned to equity financing during the downturn to make up for their cash shortage. That solution can help keep a business afloat, but each time this type of funding is raised, a company must be appraised, says Jeffery Sohl, the director of the University of New Hampshire's Center for Venture Research. If owners revaluate their companies when values are lower, they may have to hand over more ownership in the company because the same amount of money buys more when values sink, he says.

In an effort to shore up his firm's valuation, Butler decided to forgo traditional equity financing. Instead, he issued convertible debt, which is seen as less risky than regular equity investments. The strategy has paid off. Since February, Butler has managed to raise $1 million in debt financing.

Butler was able to avoid a lower valuation, but many other business owners — especially those who are older and angling for retirement — haven't been so lucky. In the second quarter, the median sale price for completed business sales dropped 20% to $160,000, from $200,000 the year before, according to BizBuySell.com, a web site that tracks business sales. "There's no question that it's a challenging environment," says Anthony J. Citrolo, a principal at New York Business Brokerage, a business brokerage firm in Melville, N.Y. "If the last three or four quarters haven't been great, some owners [looking to sell now] will have to accept about 12% to 15% less than what they would have gotten a year ago," he says.

Still, low valuations aren't impossible to overcome, says Citrolo. In fact, they might even benefit some business owners, he says. Here are three ways to sell your business when values are low:

Keep it in the family
For business owners who want to keep their companies in the family, now may be an ideal time to hand over the reins, says Matt Painter, a tax partner at LBMC, an accounting firm in Brentwood, Tenn. The total amount any one person is allowed to give away as a gift, tax free, over his or her lifetime is $1 million. So at this point, business owners can effectively give away a larger percentage of their businesses because valuations are lower, Painter says.

Let's say a business that was worth $2 million a year ago was broken down into 10,000 shares worth $200 each. Let's also say that business lost 20% of its value after the downturn, sinking the firm's shares to $160 each. So instead of being restricted to giving away 5,000 shares (to stay within the $1 million exclusion), the owner can now give away a larger percentage of her business (6,250 shares) to her children. The move could also mean a windfall in the recovery. "Depressed values are [likely] going to bounce back," Painter says.

Transition to employees
At a time when buyers are scarce, another option for owners is to sell the firm to its employees. Of course, buying a business on the spot is likely a stretch for cash-strapped workers. In addition, taxes, which are payable by employees, kick in on stock transfers to employees, says Matt Vandenack, an attorney who counsels small-business customers for the Principal Financial Group in Des Moines, Iowa. Still, as valuations are lower, so are taxes, he says. As a result, employees may be more willing to purchase the company via stock transfers today, Vandenack says. "It's an opportunity to get into the business for cheap," he says. "If you sell them a portion of the business today, that percentage of the business will presumably increase. And even if the company's value goes up before [employees] finish buying it, they've at least gotten a discount on a portion of the business."

Sell with earning potential
Getting anyone to pay for a business in full is a tough proposition these days. And although seller financing — transactions in which sellers agree to hand over the business in return for installment payments — has picked up steam, it doesn't encourage business owners with low-valued businesses to sell. Instead, many owners are increasingly turning to transactions known as "earn outs" in which business owners agree to sell their lower valued firms today in exchange for a cut of the company's future profits, Citrolo says. Here's how it works: Sellers and buyers agree on future earnings targets. If buyers meet these targets, sellers receive some agreed upon percentage over and above the target value, Citrolo says. However, if the buyer doesn't meet his target, the seller still receives payment. "In effect, the buyer is hedging his bet," he says.