How to buy or sell an engineering business
Control Engineering has been running a 9-part series on business valuation. Many thoughtful methods are employed in business valuation. Here is another view.
The basics of a business valuation
The value of a business depends in large on the purpose of the valuation. A value for an estate is substantially different from a value for a purchase or sale. What really counts in the sale scenario is what the value would be to the subsequent owner. History, while it may be a guide, isn’t the main determining factor. Instead, what is it going to be worth going forward is the key.
Additionally, solely denigrating multiples [some multiplier of a number from the income statement] is misleading. They can be useful for comparisons to other similar businesses. You can’t ignore them, just do not rely on multiples to the exclusion of other practical measures. Here is a list of factors that have significant value for a business:
- Sole ownership and control
- Integrating a useful technology for cost reduction or operation improvement.
- The future income stream from a unique process, technology, or an exclusive customer.
The likelihood of a disruption or cessation of a unique quality is difficult to evaluate but still must be considered. For example, a unique relationship forecasted huge results in the future which turned out to be true. Systems sold like hot cakes for several years, but fell apart when two layers of procurement down the line fell into dispute, legal actions, and bankruptcy. Fortunately, the buyer earned more than enough in the fruitful years to justify the whole acquisition.
Organizing the business valuation process
Another thing to consider is that some consultants will say it takes a long time to develop a value. However, this depends on how the valuation process is organized. Use an outsider to conduct the business valuation and internal resources to gather the necessary information. For example, internal staff can gather information about history, projections, competition, technical information, post-sale integration, cost impacts, staffing, marketing, and other factors, so you aren’t paying more for clerical work that is unnecessary or gold-rimmed report packages.
Don’t pay for valuation work as a percentage of the "number." While a good valuation job has elements of an appraisal, it’s not like an appraisal for tax purposes. Much of your judgement in either selling or buying involves speculation about what could happen if buying or selling the business goes well. Also think about the downside if it doesn’t go well. Not only will that affect you immediately but it can affect you the next time a business might be bought or sold.
Selling or buying a business
An engineering business can take many forms. Most are like any professional practice, that is, doing work for clients and charging for the time involved or the service delivered. For some other types of professional practices, like an accounting firm, lawyer’s office, or an insurance brokerage, a number of clients make up the revenue base. Some professional practices can have very few. This impacts the business value.
Typically, such businesses are sold or bought based on a multiple of revenues (like three times the average of three to five years’ sales). The more diversified the business, the better the multiple will be assuming average profitability. Perceived risks of dependence on a single client or just a few major clients may reduce the multiple and therefore the price. The engineering firm may benefit from diversification.
Consider if there is a large potential in which the buyer is interested, like an exclusive but only partially-developed proprietary technique or process. Using a base price plus an "earn out" can provide the desired safety for the buyer and the deserved rewards for the seller. For example, a business that was sold had a two-year additional payout depending on gross profits over a base level. The first year was very profitable, but plummeted in the second when the key customer’s sales dropped.
Putting the business valuation together
Developing a rationale for the sale or purchase of any business requires the care, knowledge, and experience of a professional who has performed a business valuation. There are good investment bankers and high-quality consultants who can guide business owners effectively. Use your staff to get the numbers together and rely on outside help and your own expertise to develop the business valuation. Remember, no one formula is right for every business.
Peter H. Burgher, CPA, AB, MBA has been an expert witness for 36 years during which he has developed, operated, and sold several technology-based businesses. Prior to that he was a managing partner in an international CPA firm. Edited by Emily Guenther, associate content manager, Control Engineering, CFE Media, firstname.lastname@example.org.
- The process of conducting a successful business valuation.
- Understanding the factors that could impact a business’s value.
- Identifying the steps to properly conducting a business valuation.
Is the business valuation process the same for new and old businesses that have a longer performance history?