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Determining the value of an owner-managed business in a reasonably accurate and factually correct manner is anything but trivial and is of central importance for the subsequent successful sale of the business. As a general rule, this process always begins with a confidential discussion between the business owner and their tax advisor, which can sometimes be helpful but, in practice, often provides little to no assistance because the tax advisor typically lacks market knowledge and, in extreme cases, even the knowledge of how to properly value a business. In Germany, this is actually clearly regulated by the IDW S1 standard and its simplified versions, and using the so-called multiplier method (when applied correctly), one can relatively easily and quickly determine an approximate value range on one’s own. For obvious reasons, a truly reliable company valuation is generally only obtained from an M&A advisory firm with market experience, because such a valuation involves more than just performing calculations.
Either way, this leads to a company value—usually more of a value range—within which a planned sale of the company can be carried out with a relatively high probability. Armed with this knowledge, business owners expect—in the course of the subsequent marketing process—to receive exactly this company value in full as the purchase price at the time of transfer. This is a complete misconception and almost never happens in this form!
Since the company’s success is generally highly dependent on the entrepreneur as an individual, agreements are regularly reached regarding transition periods following the sale, during which the entrepreneur continues to serve as managing director or in an advisory capacity, and the parties work together to gradually compensate for the owner’s departure. It should be clear that during this transition phase, no buyer will rely solely on the seller’s goodwill but will instead seek to protect their multi-million investment through various safeguards.
These include, for example, so-called “earn-out” provisions, under which the entrepreneur receives only a portion (e.g., 50–80%) of the total purchase price at the time of the handover and receives the remainder of the purchase price—in full—depending on the achievement of specific business targets (typically operating profit) over the following 2–3 years. Such arrangements are now standard in the majority of business sales. Similarly, lenders (especially financing banks) often require the entrepreneur to provide a so-called subordinated seller’s loan (10–20% of the purchase price) as a commitment to the transaction; this loan is usually not repaid until after 5–8 years but, in return, typically bears a relatively high interest rate. As a side effect, this can usually also be used as collateral for guarantees to be provided in the business purchase agreement; otherwise, corresponding guarantees (10–50%) would be required at this point, which tie up a portion of the total purchase price for the duration (usually 2 years) of the guarantees.
It is also quite common to require the seller to retain a minority stake or a stake in the acquiring company. Depending on the structure, this can be very lucrative for the seller.
Ultimately, the key variable is the total transaction value, which comprises all of the aforementioned elements. The total transaction value may be higher or lower than the previously determined enterprise value. This depends almost exclusively on how successful the prior marketing efforts were, what the current market situation is like, and whether your own sale is happening at the right time and in the right place. Depending on how one has acted in this regard, the outcome can sometimes be very gratifying, but at other times very sobering. Here, it is crucial for every entrepreneur to carefully consider how and with whom they will tackle such a project. Making the right choice determines the success of what is usually the most important commercial venture in an entrepreneur’s life!
This article was first published in December 2024 in “UNTERNEHMERGEIST” (online and print).
