June 4, 2014

Nearly one in three sales of a business enterprise fell through during the past year, most because of a valuation gap in pricing, according to a new study.

And the price gap for those transactions that didn’t close was most often between 21-30 percent, the 2014 Capital Markets Report of Pepperdine University found in surveys with 141 investment bankers.

The primary reasons deals terminated were:

  • Valuation gap in pricing (26 percent)
  • Unreasonable seller or buyer demand (20 percent)
  • Economic uncertainty (12 percent)
  • Insufficient cash flow (11 percent)
  • Lack of capital to finance (11 percent)
  • No market for business (10 percent)
  • Seller misrepresentations (4 percent)

Dollar ChainSurveys with 40 brokers found similar results, though more brokers saw deals end because of buyers or sellers who made unreasonable demands.

Of transactions that were closed by investment bankers during the past 12 months, most were in manufacturing. The least number was in construction and engineering.

Most sales took between eight months and a year to close, but about one sale in four was able to close in six months or less.

The types of businesses that had most successfully completed sales were:

  • Manufacturing (20 percent)
  • Business services (17 percent)
  • Consumer goods and services (12 percent)
  • Financial services and real estate (10 percent)
  • Information technology (9 percent)
  • Healthcare and biotech (8 percent)
  • Wholesale and distribution (7 percent)
  • Basic materials and energy (6 percent)
  • Media and entertainment (4 percent)
  • Construction and engineering (4 percent)

Investment bankers said there is an imbalance between companies worthy of financing and capital available.

There is a shortage of capital for companies that have less than $10 million in EBITDA (earnings before interest, taxes, depreciation and amortization), they said. For companies with more than $10 million in EBITDA, there is a surplus, the survey found.

The most popular valuation method used by investment bankers for valuing privately held businesses was discounted future earnings. Valuation methods included:

  • Discounted future earnings (32 percent)
  • Guideline company transactions method (20 percent)
  • Capitalization of earnings method (15 percent)
  • Guideline public company method (11 percent)
  • “Gut feel” (6 percent)
  • Adjusted net asset method (6 percent)

When using multiples to determine the value of a business, more than half used recast (adjusted) EBITDA multiple, followed by revenue multiple and EBITDA (unadjusted) multiple approaches.

This year, one-third of investment bankers and brokers expect to close six deals or more, and two-thirds expect to close between one and five deals.

This article was originally posted on June 4, 2014 and the information may no longer be current. For questions, please contact GRF CPAs & Advisors at marketing@grfcpa.com.