Why your business may be worth more (or less) to you than a buyer

August 8th, 2011

Introduction

• Background for today’s topic– What is your business worth to you– Why owners and buyers can value the same

businesses differently– Real world examples

• Who we are– Frank Stiff, President - Cheval Capital– Ryan Elledge, Chief Operating Officer – Codero

• There are three ways to value anything– Based on the future cash flows– Price that someone will pay for it in the market– Cost to build it yourself

• In hosting, the first two methods are linked. Each is based on the future cash flow of the business.

• Future cash flows converted to a value using a rate of return (aka discount rate)

Valuing Your Business

Valuing Your Business (Cont.)

• For example, $100/year for 5 years is worth – $500 at a 0% rate of return– $335 at a 15% rate of return– $244 at a 30% rate of return

• Rate of return based on risk

• Strategic, operating & personal issues can play a role

Why Do Owners & Buyers See Value Differently

• Market conditions • Operating efficiency of each party• Buyer’s business focus• Perception of risk • Hidden assets and liabilities

Market Conditions That Lower Value

• Other sellers of similar businesses– The buyer can purchase another similar business

for less.• Easy to grow organically– The buyer can add customers organically for less.

• Unusual market events– 1&1

• A lot of buyers• When organic growth is more expensive than

acquisition• Unique assets or a hot product• Location

Market Conditions That Raise Value

Operating Efficiency of Each Party

• Would your company produce more or less cash for you than the buyer?

• Are there secondary benefits to the buyer from your products or customers? – Cross sales of your products & services– Cross sales of buyer’s products & services

• Are there personal expenses in financials that Buyer would not incur?

Buyer’s Business Focus

• Does the Buyer want all of your business or just a portion of it?

• They may value only what they want to keep

Perception of Risk

• Buyer’s perception of risk can have a big effect on their value

• Typical issues– Customer base has close personal ties to owner– Highly customized services– Pricing significantly different than the market– High growth rates

• Red Flags– Poor to no financial and other business records– Poor to no customer attrition figures

• Assets– Non-CF assets the buyer needs (e.g. pre ARIN /15’s)– Products the buyer can sell to their base– IP or products/services that can be spun off into a new

business• Liabilities– Old equipment / future capital expenditure needs– Operational details that raise migration costs– Pay in advance customers– LT facilities leases

Hidden Assets & Liabilities

Effect on Cash Flow and MultiplesOperating Cash Flow

Example A Example BAnn Rev Seller Buyer Seller Buyer

Shared business $ 1,000 $ 300 $ 400 $ 150 $ 400 Design business $ 400 $ 60 $ - $ 20 $ - Total revenue $ 1,400

Perceived Buyer Risk (e.g. Attrition) $ - $ (40) $ - $ (40)Net Cash Flow $ 360 $ 360 $ 170 $ 360

Purchase Price as a Multiple of Op Cash FlowPurchase price $ 1,400 3.9x 3.9x 8.2x 3.9x

* - No Taxes* - No capital expenditures or other transaction costs

Effect on Cash Flow and MultiplesOperating Cash Flow

Example A Example BAnn Rev Seller Buyer Seller Buyer

Shared business $ 1,000 $ 300 $ 400 $ 150 $ 400 Design business $ 400 $ 60 $ - $ 20 $ - Total revenue $ 1,400

Perceived Buyer Risk (e.g. Attrition) $ - $ (40) $ - $ (40)Net Cash Flow $ 360 $ 360 $ 170 $ 360

Purchase Price as a Multiple of Op Cash FlowPurchase price $ 1,400 3.9x 3.9x 8.2x 3.9x

* - No taxes, capital expenditures or other transaction costs

Effect on Cash Flow and MultiplesOperating Cash Flow

Example A Example BAnn Rev Seller Buyer Seller Buyer

Shared business $ 1,000 $ 300 $ 400 $ 150 $ 400 Design business $ 400 $ 60 $ - $ 20 $ - Total revenue $ 1,400

Perceived Buyer Risk (e.g. Attrition) $ - $ (40) $ - $ (40)Net Cash Flow $ 360 $ 360 $ 170 $ 360

Purchase Price as a Multiple of Op Cash FlowPurchase price $ 1,400 3.9x 3.9x 8.2x 3.9x

* - No taxes, capital expenditures or other transaction costs

Effect on Cash Flow and MultiplesOperating Cash Flow

Example A Example BAnn Rev Seller Buyer Seller Buyer

Shared business $ 1,000 $ 300 $ 400 $ 150 $ 400 Design business $ 400 $ 60 $ - $ 20 $ - Total revenue $ 1,400

Perceived Buyer Risk (e.g. Attrition) $ - $ (40) $ - $ (40)Net Cash Flow $ 360 $ 360 $ 170 $ 360

Purchase Price as a Multiple of Op Cash FlowPurchase price $ 1,400 3.9x 3.9x 8.2x 3.9x

* - No taxes, capital expenditures or other transaction costs

Effect on Cash Flow and MultiplesOperating Cash Flow

Example A Example BAnn Rev Seller Buyer Seller Buyer

Shared business $ 1,000 $ 300 $ 400 $ 150 $ 400 Design business $ 400 $ 60 $ - $ 20 $ - Total revenue $ 1,400

Perceived Buyer Risk (e.g. Attrition) $ - $ (40) $ - $ (40)Net Cash Flow $ 360 $ 360 $ 170 $ 360

Purchase Price as a Multiple of Op Cash FlowPurchase price $ 1,400 3.9x 3.9x 8.2x 3.9x

Price at a rate of return equal to 20% $ 1,800 $ 850 25% $ 1,440 $ 680 30% $ 1,200 $ 566

* - No taxes, capital expenditures or other transaction costs

Effect on Cash Flow and MultiplesOperating Cash Flow

Example A Example BAnn Rev Seller Buyer Seller Buyer

Shared business $ 1,000 $ 300 $ 400 $ 150 $ 400 Design business $ 400 $ 60 $ - $ 20 $ - Total revenue $ 1,400

Perceived Buyer Risk (e.g. Attrition) $ - $ (40) $ - $ (40)Net Cash Flow $ 360 $ 360 $ 170 $ 360

Purchase Price as a Multiple of Op Cash FlowPurchase price $ 1,400 3.9x 3.9x 8.2x 3.9x

Price at a rate of return equal to; 20% $ 1,800 $ 850 25% $ 1,440 $ 680 30% $ 1,200 $ 566

* - No taxes, capital expenditures or other transaction costs

• The cost of any activity measured in terms of what the activity you didn’t choose

• When you choose to sell your business you’re doing two things– Giving up the cash flow from the business for the

purchase price– Getting the opportunity to do something else

• Factor in the value of “doing something else”

Opportunity Cost

• Adverse market conditions – Don’t sell, wait, refocus business

• Buyer gets less cash flow than you do – Find a better buyer

• Buyers business focus – Find a better buyer, sell separately

• Perception of risk – Fix your financials & systems• Rate of return requirements - Don’t sell, find a

better buyer

What Do You Do If …

• CommuniTech.net (CT) acquired by Interland in 2002 – a revenue based multiple

• CT valued its proprietary intellectual property very high – complete automation, advanced control panel

• No multiple kicker for technology; INLD intended to migrate to own (fragmented) systems

Transaction Example

• Aplus.net (A+) spent considerable time in 2006/2007 attempting to purchase large hoster, part of a publicly traded organization

• Target had a unique, advanced platform and significant engineering talent – both needed by A+

• A+ offer was strictly revenue based; declining revenues led to decrease in offer and no transaction resulted

• Completion of the transaction could have significantly enhanced A+

Failed Transaction

Why your business may be worth more (or less) to you than a buyer

August 8th, 2011

Frank StiffCheval Capital

fstiff@chevalcap.com

Ryan ElledgeCodero

ryane@codero.com