Valuing and selling my California business in 2021
Planning to sell your small business in 2021? View market insights that help you value and sell your California business in 2021.
As we move into the close of 2020, there is no doubt it is tempting to look at this year with enormous regret and frustration.
If we own and operate a business in California … and it is still operating … and we have our health, there is no choice but to be grateful. As we are entrepreneurs, it is as good as it gets as we now have hope for a vaccine to defeat the Coronavirus, a difficult 2020 election is close to resolution, if you look at the US Stock market it just hit an all-time high, interest rates to borrow money and build a business are at an all-time low, technology is bringing change and innovation and there is plenty more.
Many entrepreneurs are weary or want to move away from the day-to-day responsibility of owning and operating a business.
So how does 2021 look if you want to value and sell your business in California?
Why valuing and selling a California business is different
If you are asking yourself the question, is California a good place to own and operate a business and you are reading the news, you may be hearing businesses are leaving California in droves?
There is no question, there are challenges. However, a good question is, why would you do business in any other state when there are many things going for it?
The State of California is going through challenges in 2020 as it has been hit hard by COVID-19. The San Francisco Bay area has been hit exceptionally hard as homelessness from COVID-19 has shut down the 6 Bay Area counties where the cost of living is so high.
You might ask yourself the question, “If California has so many regulations and it is more complicated to sell a business there, why are there so many businesses in California?
The answer to that question is quite simple: there are a variety of industries in California, and the economy is strong. First Research provides some amazing statistics.
- State job growth rose 1.8% in October 2019 from a year ago; national job growth rose 1.4%
- State unemployment averaged 3.7% in October 2019; the national average was 3.6%
- Personal income rose 5.2% to $2635.3 trillion in Q2 2019 from a year ago.
- Tax revenue increased by 8.3% in Q2 2019 from a year ago.
The area defined as Southern California, if it were a country rather than part of a state, would have the sixth-largest economy in the world. Northern California is home to a large portion of the tech sector and Silicon Valley. The Central Valley in California produces about 40% of the agricultural products consumed in the United States. The manufacturing industry is robust in comparison to many other parts of the country.
Of course, that results in a variety of support industries as well. From HVAC and custom home remodeling to medical practices and auto repair shops, there is no end to the types of businesses that can be operated successfully in California.
To do so, though, it is necessary to know that there are challenges to doing business here.
What is happening in your industry?
COVID-19 has had a direct impact on every industry in the United States. Probably the business that has had the most positive impact is Amazon. As someone said, Amazon was built for a pandemic.
For those of us that are not Jeff Bezos, it has been necessary to watch what is happening in our industry and react.
There are 15 industries in that I have actively assisted with the valuation and sale of a business. These industries are:
Questions to prepare and have answers if selling your business
If you are considering selling your business be it in 2021 or 2022, consider your answers to the following questions, as potential buyers will ask most if not all of these questions.
- How and what has been the effect of COVID-19 on the operations of the company?
- How are the changes in technology impacting the company?
- What emerging technologies are influencing the company’s product development strategy?
- What are the key drivers of demand for the company’s products?
- What new geographic markets look most promising to the company?
- How much does the company rely on third-party suppliers?
- How many patents does the company hold?
- Who is the company’s primary consumer base?
- How important is the company’s brand to its success?
- What complementary products or services does the company offer and market?
- What percentage of the company’s revenue do R&D expenditures account for?
- What policies does the company have in place to account for, or collect, products or services after their useful life?
- What is the company’s pricing strategy?
- What challenges does the company face in recruiting new employees?
- Who are the company’s primary competitors for top talent?
- What incentives does the company use to attract and retain employees?
- In which quarter does the company earn most of its revenue?
- What portion of the company’s products are purchased using credit financing?
- What opportunities exist for the company to provide additional products or services?
What is happening in the business for sale market?
With COVID-19 in full swing during most of 2020, it would be tempting to think that businesses for sale are not selling.
If that is your perception, you would be wrong.
Here are two reports for you.
The first is from BizBuySell and their 3rd Quarter of 2020 Insight Report. The second is from the M&A Source and IBBA and their 3rd Quarter of 2020 Market Pulse report. I am a member of both the M&A Source and the IBBA.
BizBuySell 3rd Quarter of 2020 Insight Report
Below are some data points including charts from the BizBuySell’s Insight Report. The BizBuySell’s Insight report looks at small business confidence and recent business for sale transactions to get a snapshot of what is happening in the Businesses for sale market.
The 3rd Quarter of 2020 of BizBuySell’s Insight Report shows a steady upward trend in sales since the pandemic hit very early in 2020. In April 2020, the transactions showed a 51% year over year decline. However, that was the low point of the market with a decline in July 2020 declining to 21% in July, and then in September 2020, declining to just 5% fewer deals in September 2020.
As is normal in the capitalist system, the reason behind the resurgence appears to be demand-driven businesses.
According to BizBuySell’s 2020 Small Business Confidence Study, buyer confidence reached a record high of 60 compared to 53 a year ago.
The Small Business Confidence Index scores sentiment on a range from 0 to 100 using survey responses from over 2,300 small business owners, with 50 representing neutral confidence and 100 representing certainty and an idealized, perfect environment. Of buyers surveyed, 57% believe they can buy a business for a better value than last year. This is a dramatic turn as just 17% believed the same when asked in 2019.
Separately, owner confidence fell to a low of 45, down from 52 in 2019, with the main driver being concerned over business value. Owners validate buyer sentiment, with 68% surveyed believing they would have received a better value if they had sold last year – almost double the 37% surveyed in 2019. Intuitively, 71% of these owners pin a lower value on being impacted by the pandemic.
Revenue and Cash flow metrics
The chart below highlights the following:
- In the 3rd Quarter of 2020, the number of closed transactions dropped by 16%.
- The businesses that sold were able to exhibit solid growth as the median revenue of sold businesses grew 14.2% from $554,764 to $633,494.
- Additionally, the median Cash Flow increased 8.1% from $125,000 to $135,119.
- The average Multiple of Cash flow reported has remained consistent at 1.5% growth, from 2.37 in Q3 2019 to 2.41 in Q3 2020.
Sale Price V Asking Price
During the 3rd Quarter of 2020, the median sale price of businesses sold was $299,500 which is a jump from a year ago by 19.8%.
The listing price or asking price saw a similar increase from a year ago by 17.6% from $299,500 to $327,000.
These strong increases are an indication of the types of businesses transacting in the COVID-19 era. With many businesses negatively impacted by the pandemic, buyers with means are paying a premium for resilient businesses that are thriving well past pre-pandemic levels. At the same time, the impacted businesses which would have sold prior to the pandemic are now having a challenging time or staying on the sidelines altogether.
Sales by Industry sector
The BizBuySell Insight report deals primarily with Main Street businesses. This, therefore, includes restaurants, bars, hair salons, and other non-essential businesses that have been hit hardest by COVID-19.
Thirty percent (30%) more restaurants sold in Q3 versus Q2, while maintaining the same median sale price of $150,000. This is a positive sign for a sector that has been hurt by the pandemic and prone to asset sales.
Elsewhere service businesses saw a 35% gain in transactions versus the Q2, with retail businesses jumping 50% and manufacturing doubling in volume though with lower sample size.
What is happening with businesses sold in California?
The State of California has a large and diverse economy. Because the State of California is so large, it is useful to look at some regional statistics from San Diego, CA in the south to Sacramento, CA in the north, and five other regions.
Closed Businesses for Sale Transaction for California regions during 3rd Quarter, 2020
Market Pulse 3rd Quarter of 2020 report
Below are some data points including charts from the IBBA and M&A Source Market Pulse report 3rd Quarter of 2020 report.
The survey is obviously conducted each quarter. For the 3rd Quarter of 2020, there were 25 questions given to the members of the International Business Brokers Association (IBBA), its Affiliates/Chapters, and/or the M&A Source.
The responses were collected from October 01 to October 15, 2020, and where appropriate, compared against the results from the same period in 2019.
The goal of the Market Pulse Report is to provide quality information on a quarterly basis for both Main Street and Lower Middle Market transactions.
There are 9 slides in this series.
Typical size of a business transaction.
This first chart provides a summary of the typical size of business transactions by breaking them down into 5 categories and comparing them to the 3rd Quarter of 2019 and the 3rd Quarter of 2020.
The 5 categories are:
- Deals with a value of under $499,999,
- Deals with a value from $500k to $999,999,
- Deals with a value from $1mm to 1.99mm,
- Deals with a value from $2mm to $4.99mm,
- Deals with a value from $5mm to $50.00mm.
Business transactions sold by Deal Size in 3rd Quarter of 2019 Versus 3rd Quarter of 2020.
This second chart looks at the number of business sales that closed in the 3rd Quarter of 2019 in comparison to the 3rd Quarter of 2020.
As you would expect, the smaller the deal size the more businesses sold.
Change in new clients by Deal Size in 3rd Quarter of 2019 Versus 3rd Quarter of 2020.
This third chart shows the activity in business owners deciding to list their business for sale. The chart looks at the size of the business transactions and compares this to the 3rd Quarter of 2019 to the 3rd Quarter of 2020.
In most categories, there is an increase in the number of business owners deciding to sell their business in the 3rd Quarter of 2020 when comparing to the 3rd Quarter of 2019.
The median number of months from Listing to the Close of the sale of the business
This fourth chart shows the Median number of months from when the business is first listed or advertised for sale and the sale of the business finally closes.
The smaller the business the quicker the sale closes. However, it still takes take being a minimum of two months to a maximum of five months.
Additionally, there is no question that it has recently been taking longer to close the sale of a business in 2020 due to COVID-19 and the banks being slower to process their loan approvals.
The median number of months from Offer to the Close of the sale of the business
This fifth chart shows the Median number of months from when the seller received a Letter Of Intent or Offer for the business and the sale of the business finally closes.
The smaller the business the quicker the sale closes. However, it still takes take being a minimum of two months to a maximum of five months.
Median SDE Multiple Paid
This sixth chart shows the Median SDE multiple paid when comparing the 3rd Quarter of 2019 and the 3rd Quarter of 2020.
It is interesting to note that the multiple paid increases as the EBITDA increases.
It is also interesting to note that the multiple paid in 2019 in each category was higher than in 2020 except if the value of the business was between $5 million and $50 million.
Median EBITDA Multiple Paid
This seventh chart shows the Median EBITDA multiple paid when comparing the 3rd Quarter of 2019 and the 3rd Quarter of 2020.
It is interesting to note that the multiple paid increases as the EBITDA increases.
It is also interesting to note that the multiple paid in 2019 in each category was higher than in 2020.
Median Percentage of Final Selling Price Versus Asking Price.
This eighth chart shows the expectations of the Business Intermediaries and M&A Advisors about the median percentage of final selling or sold price compares to the asking price. The comparison is for the 3rd Quarter of 2019 and the 3rd Quarter of 2020.
It is interesting to note that the higher the final selling price, the greater the chances of business selling.
Expectations of Business Listings / Engagements from New Client in the Next 3 months
This ninth and final chart shows the expectations of the Business Intermediaries and M&A Advisors about new businesses coming to market in October, November, or December 2020 compares to the same period in 2019.
What is happening in the M&A Market?
The M&A market, according to different perspectives on the website called The Middle Market, Private Equity will be in a strong position to make targeted acquisitions.
This is because:
- Financing is readily available at historically low-interest rates. This especially applies to Private Equity with a strong track record.
- Businesses that now come onto the market means Private Equity will see the performance of these businesses from 2016-2019, but more importantly, during 2020 and COVID-19. If a business was able to perform well in 2020, the expectation is that the business will be worth more than those businesses that did not.
- COVID-19 and 2020 came with a lot of uncertainty. With different vaccines now starting to ship, the goal is to move the country to at least a 75% rate of vaccination and this will manage the spread of the virus. An equal uncertainty has been the normal 4-year cycle of a Presidential election. For all intents and purposes, this has now been decided and the market is beginning to see the policies and personalities of the new administration. Tax policy may change but the expectation is that it will not be too much different.
- An interesting side effect from COVID-19 has been a reduction in travel and more working-from-home and ‘Zoom meeting.’ If a business for sale is well run and financial statements are clean, it is much easier for a buyer and their acquisition team to focus. If the buyer really wants to see the business before making a final decision, drone technology is a simple way to allow that to happen.
How do I make my business in California sellable in 2021?
Do you remember the movie, Field of Dreams? If so, you will remember these classic lines from Field of Dreams; ‘If you build it, they will come.’ Perhaps this is a little optimistic, but if you prepare and build the right components, it will increase your chances of selling your business in California in 2021.
Owning and operating a business in California, already comes with challenges. This is not an exhaustive list, but it does include:
- The minimum wage is higher than in many other states. If you hire entry-level workers at this pay rate, your bottom line will be affected, and business buyers will need to be aware of this.
- In 2020, the California Consumer Privacy Act is being put into place. This act goes further than GDPR in some areas and not as far in others, but it is likely a precursor to Federal action on consumer privacy.
- California Assembly Bill 5 (often abbreviated as AB4) went into effect this year as well, and it regulates which workers can be considered independent contractors and which ones will have to be considered employees. If you normally sub-contract work in your business, you will want to pay close attention to this change in regulation.
- Changes in business technology that originate in Silicon Valley disrupt industries closest to them in California first, often a pressure point for businesses to keep up with their competition.
- California has a high level of consumer protection. This, therefore, includes licensing requirements for common types of business such as the construction industry, auto repair industry, medical practices, and more.
Other factors to consider so you can successfully sell your business are:
- Separate yourself from the business. It is not unusual for the owner to be the face decision-maker, policymaker, CEO, CFO, CTO, HR department, and more. If you are all these things for your business and you would like to sell the business, put your feet in the shoes of the buyer who worries that when you leave, there will simply be a need to learn too much and take the risk they will make mistakes…and so they will look at other businesses to buy.
- Are the financial statements accurate and just as importantly, up to date? The number one cause of a business not being able to sell is because the financial statements are too challenging for the buyer to accept. Conversely, if the financial statements are accurate, this provides a level of comfort for the buyer as they can do their analysis and see if buying the business fits with their investment criteria including the ability to get finance; as most buyers need to do.
- The public face of most businesses these days is social media to promote their product or service. If your business just uses personal accounts, this will be negative for a buyer as all the followers and goodwill that has been built will not be able to transition to a buyer. So, separate your personal and business social media now and be prepared to wait to sell your business.
- The size of a business does matter. The higher the gross revenue, the higher the number of identifiable customers, the higher the number of key employees in place, and the easier the business generates its revenue the better.
- More is not always better. If you have one customer that makes up more than 15% of the gross sales of the business this is a negative. A buyer is looking at customer concentration with concern if a major customer leaves during the transition of the sale of the business, it may too negatively impact the bottom line and so it is a risk they are not willing to take.
- Finally, growth is good. A buyer decides to buy a business for two primary reasons. The first reason is the free cash flow. The free cash flow allows the buyer to repay creditors, pay dividends, pay interest, and very often, support the lifestyle of the owner of a privately held business.
How do I make my business in California attractive to buyers?
Each business in each industry has a unique set of factors.
Selling a business is difficult whether you are in the California manufacturing industry with its state and county regulations, environmental laws, or the California construction industry with its consumer protection and union and non-union workforces, or medical practice with the pressures of working in difficult federal and state regulations, idiosyncrasies and overhead of medical billings be they Federal or State or Health Insurance companies and more.
Share the vision of your business
A buyer will buy a business for many reasons. There are two critical reasons that are non-negotiable, and these are:
- The cashflow or Sellers Discretionary Earnings the business generates.
- The potential of the business…and to state the obvious, it must have positive potential.
An advantage that buyers have in the 2020 COVID-19 environment is that they can see both these factors. That is, all businesses in 2020 have worked under a 100-year event with COVID-19 or this pandemic. Many businesses have been hurt with some businesses having no choice but to close. They hurt businesses are obvious as these include businesses in the restaurant, bar, hair salon, and travel industry. However, other industries have been hurt such as a medical billing business that had to close their doors as some medical practices were closed and therefore the business was unable to do the medical billings for the doctor.
If you plan to sell your business, ensure you share the vision of your business so the buyer understands opportunities they may not have considered.
Another critical piece to remember is that the business seller gets to work long days and hours, but they also get to work the hours that suit them. I am working with a business owner that sells forklift trucks and related services. He chose to hire a Sales Manager and provide them with a huge sales incentive. This decision still brings the business a great return on their business but also allows her to live her own lifestyle, which she loves.
As you sell your business, do not forget to sell your lifestyle and cash flow. Make sure you can defend the cash flow as the buyer will probably need a loan and the loan will only be approved if the lender is comfortable with the tax returns and supporting financial statements.
Does a PPP loan affect the value of my business?
The PPP loan forgiveness forms are now readily available. If you want to know the right steps to apply for PPP loan forgiveness it is very simple. Do not ask other business owners what they have done or a well-meaning friend. Simply ask your PPP lender. Some PPP leaders are outsourcing this service, but the PPP lender is responsible for helping you with the PPP loan forgiveness process. If the PPP lender gets it wrong, they will have to answer to the SBA, so they have a huge incentive to get it right.
Before you start the PPP loan forgiveness process, make sure you report it correctly on your financial statements.
Most financial institutions are not recommending showing the income from the PPP loan on the Income Statement or P&L as the expenses are not deductible.
Check with your accountant or bookkeeper with the debit and credit entries they wish you to show. It is likely that when Congress passes a new stimulus, they will tidy up some of the languages of these loans as the IRS has issued their guidance and it is probably not what Congress intended with the CARES Act when it was passed.
The next steps
To prepare a personal business valuation which includes an 18-page report, the document necessary would be the last 3 years tax returns of the business, a recent Profit and Loss Statement, and a Balance Sheet.
This link to a page on my website is to a Sample Business Valuation.
If you are a ‘Do It Yourselfer’ and would prefer to learn the steps to value your business, you can learn more here and sign up for our email service by going to this page of my website – Steps to Value Your Business.
Contact Us to value and sell your business
If you have questions about the value of your business or the steps it takes to sell a business, please reach out to us using the “Contact Us” page to introduce yourself and we will get back to you.
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