Agreeing on a fair business valuation-covid related profitability increase

August 26, 2022

by a searcher from Brigham Young University in Highland, UT, USA

I have found a handful of businesses that have done exceptionally well in###-###-#### This is often in the service industry as a result of the uptick in construction needs throughout Covid. One particular business I am looking at had a 30% increase in profits from '19 to '20 and then a 20% decrease from '20 to '21.

How do you get brokers and sellers to realize that the increase in profits is not sustainable and the multiple should not be based on a great year that was out of the ordinary? It is hard to tell people that their baby is ugly. What are the best ways you have been able to communicate this without hurting feelings?

It seems to me that part of this should be the broker's role and it would help them close more deals. If not, they'll continue at the rate they are going selling 30% of the businesses that they list.

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Reply by a searcher
from University of Queensland in Brisbane QLD, Australia

Whilst it's part of the brokers role, it's rarely explained by brokers. There are a number of reasons for this but more to your question, I've found it useful to forge great buyer/seller relationships first. That's the 1st step to "communicating anything potentially sensitive". Then the 2nd step is to explain the principle concept of a fair market valuation is based on "maintainable, repeatable profit". That is, rare events such as legal disputes, COVID-related govt support or insert any other COVID-related income etc etc aren't repeatable earnings that are maintainable. Then use historical earnings to illustrate this. Then say hence the resultant valuation can't be maintained on those same grounds. Then say "I'll need x years to pay off that suggested x multiple, but I'm uncomfortable about the new companies ability to repeat that same level of profit for the next x years. And for the reasons I've just explained. Can you help me understand how I can still make that work my end?". Then explain this to the broker and indicate that it's difficult for you to see the value in continuing unless they can see and agree on fair "maintainable earnings". Aim is to get the broker to help where possible on vendor's unrealistic expectations - the broker will want this to settle for their commission. But if still no joy, but your NPV, DSCR, cashflow levels or other suitable metrics still support it and you're still excited about it then offering a bridging amount via an earn-out or vendor finance that still makes sense for you and the vendor, could be used. If vendor doesn't at least understand this as a reasonable safety measure for you, yet is a great concession by you, then you'd need to consider if this really is a great deal for you. Often completion "fever" is the biggest issue in forcing a bad deal to still work. But that's another discussion point entirely. Best of luck!

Reply by a searcher
from Cornell University in Toronto, ON, Canada

There are a lot of good ideas that have been shared here. I think a good conversation piece in this situation would be proforma financials. If the company has them, it's a good indicator of how they're viewing the ups and downs and whether they're even recognizing the volatility or past drivers. If it's something you put together yourself as the buyer, it's still helpful in sharing and explaining how you view the business and its future potential. There's also always adjusted EBITDA that can bring the valuation to a more realistic range. I wouldn't worry too much about hurting people's feelings in this situation if you're being realistic and honest - it's just business, and if you feel this way, they're probably hearing it from others as well.

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