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How Valuation Answers the Question, "What Is Your Printing Company Worth?"

What is your printing company worth? Emotionally speaking, everything. But, owners contemplating the sale of their companies have to answer this tough question in an objective and a financially realistic way. Here are three common approaches to business valuation.

By Patrick Henry
Published: September 28, 2010

What is your printing company worth? What a thing to ask! At the gut level, for those who have invested lifetimes in building and growing their printing businesses, the emotional response understandably is, "Everything!" But for owners contemplating the sale of their companies, the day ultimately comes when this tough question has to be answered in an objective and a financially realistic way.

Every situation is unique, but in most instances, say Paul Reilly and Peter Schaefer, partners, New Direction Partners (NDP), sale price valuation will be determined in one of three ways: as a multiple of EBITDA, earnings before interest, taxation, depreciation, and amortization; as the proceeds from a liquidation of a company; or as the value that the seller can expect to realize from the M&A transaction known as a tuck-in.

According to Schaefer and Reilly, the first method is the most desirable. The second is to be avoided. The third, a specialty of NDP, is a sensible alternative for those who mistakenly assume that liquidation is their only endgame when the business has taken a downturn.

You're Profitable: So What?

Every owner with a company to sell would like to do it for a multiple of EBITDA, the method that typically yields the highest selling price. However, says Reilly, this outcome is achievable only for printing companies that offer some combination of profitability plus specialization or growth. Multiples in acquisitions managed by NDP currently range from 3 to 5.75, but Reilly cautions that even if a company is profitable, it may find itself at the low end of this scale if it is not also specialized or if its growth at the time of sale is not robust.

Another factor, adds Schaefer, is company size, since the larger a high-value company is, the larger the EBITDA multiple it is likely to generate. Given, for example, that a $30 million company probably will offer more opportunity as an investment than a $2 million company, its multiple will reflect that added attractiveness to potential buyers.

Once the multiple has been established, the seller and the seller's advisers can proceed to fine-tune the valuation—a task that calls for a thorough understanding of both the rules and the nuances of business accounting.

It begins simply enough: for example, a multiple of four applied to an EBITDA of $1.5 million yields gross proceeds of $6 million. This figure, however, represents enterprise value, not what will end up in the shareholders' pockets. To estimate the net proceeds to the shareholders, you must deduct debt (line of credit, capitalized leases and notes payable) along with closing costs and fees, and add back the cash.

Also in the add-back category are non-recurring expenses—items, such as above-market shareholder compensation and executive salaries, that will no longer be incurred after the deal is closed and thus can be returned to the price calculation in the seller's favor.

No Place To Get Creative

Reilly notes that these adjustments can make valuation by multiple of EBITDA somewhat subjective, particularly when it comes to adding back non-recurring costs. And while it's to the seller's advantage to make adjustments that support the desired valuation, Schaefer urges moderation when deciding what to add back.

"You embarrass yourself if you try to justify an inappropriate adjustment," he says, noting that every dollar of adjustment affects every dollar of the purchase price by the multiple of EBITDA being used. Because the buyer is well aware of this fact, says Schaefer, "the buyer will take a long, hard look at the adjustments" particularly if the add-backs seem out of line.

The good news and the bad news for owners of troubled printing companies is that they don't have to worry about the intricacies of EBITDA—they just need a plan for exiting the business with as much value as they can hope to recover on the way out. For owners in dire straits, liquidation often appears to be the only solution: closing their doors, selling off their equipment, collecting whatever receivables can be collected, paying off creditors to the extent possible, and filing for bankruptcy when no alternative to bankruptcy seems to exist.

But Reilly says that as gloomy the prospect of liquidation may appear, the reality will be worse. Forcing a shutdown means sacrificing value of receivables and inventory and settling for, as Reilly puts it, "the lowest possible price for your equipment." Those thinking about cashing out in this way should understand, he says, that "you always get less than you think you're going to get in a liquidation."

A Second Act, with an Earn-Out

What too many printers don't realize about liquidation, insist Reilly and Schaefer, is that it's rarely even necessary—not when the exit strategy known as a "tuck-in" permits the sale of the company's active, ongoing business on better terms than anything the seller could expect to achieve in the liquidation scenario.

In a tuck-in, the buyer purchases the seller's book of business and other specified assets not with an up-front payment, but through an earn-out that compensates the seller over time based on revenues from future sales. The advantage for the seller in terms of value, says Reilly, is that what would have been the total proceeds obtainable in a liquidation becomes the starting point of valuation in a tuck-in.

Besides pocketing cash from the sale of unneeded equipment and property, the former owner now can look forward to royalties on sales from the book of business acquired by the seller. Receivables, still ripe for collection, retain their value as well.

Because a tuck-in essentially permits the sale of the business as a going concern, Reilly's advice to those considering liquidation is, "you should never close your doors." Schaefer adds that NDP has seen too many cases in which just a little more foresight on the printer's part could have replaced the slim pickings of liquidation with the richer payout of a well structured tuck-in.

Not A Do-It-Yourself Proposition

Tuck-ins don't happen by themselves, and managing the complex negotiations surrounding them is best left to professionals with a track record in this form of valuation. Another thing to bear in mind, say Reilly and Schaefer, is that valuation isn't a monolithic concept applying only to the sale of a business—it may have to be calculated in the appropriate manner at other stages of a company's life cycle.

Because there are different valuation formulas for achieving different business objectives, valuation for sale price won't yield the same result as, say, valuation for gift or estate tax calculation. Case-specific professional appraisal, a service provided exclusively within the printing industry by NDP, is a must whenever the knotty but necessary question of valuation comes up.

Patrick Henry, Executive Editor for WhatTheyThink.com is also the director of Liberty or Death Communications, a consultancy specializing in research, education, promotional, and editorial support services for the printing and publishing industries.

Patrick Henry is available for speaking engagements and consulting projects. To get more information contact us here.

Please offer your feedback to Patrick. He can be reached at patrick.henry@whattheythink.com.

 

Discussion

By John Stewart on Sep 28, 2010

Dear Sir,

While I enjoyed the article by Patrick Henry titled, How Valuation Answers the Question, "What is Your Printing Company Worth?" I also have to take issue with his approach, along with the approach used by so many others, in treating depreciation as a non-cash expense and therefore available to be added back to earnings.

The primary purpose of a valuation is to arrive at a "fair market" price that will reward the seller for his past efforts while at the same time laying out the case to a prospective buyer that the business can indeed accomplish two things:

(1) Pay the new owner at least a fair market salary, and

(2) produce enough excess earnings (above and beyond salary) to allow the buyer to pay the owner his asking price over a reasonable period of time.

If a business cannot or does not produce these excess earnings, it may have little value other than what is represented by the street or market value of the hard assets.

Where the mistake is made, I believe, is in the tendency of many investors, along with appraisers, to add depreciation back to profits. This is done under the premise that depreciation, unlike most other expenses, does not represent an immediate cash expenditure. I believe this approach is terribly misguided. In fact, in some cases it is very misleading.

To quote Joshua Kennon, a popular business author who contributes frequently to About.Com, "Depreciation attempts to match up profit with the expense it took to generate that profit. This provides the most accurate picture of a company's earning power."

"An investor who ignores the economic reality of depreciation expense will be apt to overvalue a business and find his or her returns lacking," adds Kennon.

As someone who is involved on a weekly basis providing valuations for printing businesses (most with annual sales under $5 million), as well as the author of the quick printing industry's popular operating ratio studies, I can assure you that depreciation is indeed a very real expense, especially considering the fast pace of technological changes.

Just because depreciation does not represent an immediate out-of-pocket expense doesn't make it any less real, especially when taking a longer term view of the business.

A $50,000 digital copier or printer purchased today, will be valued $10,000 less in six months. Where did that money go? Was it not an expense? By the end of three to five years, it will have a street value of possibly $15,000, if that! Where did that $35,000 go? In most cases, certainly at the end of three to five years, that copier will have to be replaced either because it is worn out or difficult to maintain, or it no longer is competitive in the marketplace.

Where is the money going to come from to replace this equipment if not from earnings? It must come from earnings, and if it comes from earnings it is by definition an expense that must be accounted for. Historically, depreciation has averaged between 3-4%, regardless of profitability or annual sales.

By the way, the same arguments made above can be made for treating interest payments as real expenses as well, since they are a fact of life and must be accounted for. This assumes, of course that the new owner, just like the old owner, will periodically be required to invest in new equipment in order to remain productive and profitable.

Owners should be candid and honest with potential buyers and should avoid inflating earnings at the risk of overstating the cash flow required to maintain the business now, as well as into the future.

John Stewart
Q. P. Consulting, Inc.
www.quickconsultant.com
Author - "Print Shop For Sale"
by Larry Hunt & John Stewart

2110 S. Dairy Road
West Melbourne, FL 32904
321-727-2442 Fax 321-727-2166
www.quickconsultant.com

 

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