This is addressed to that rare breed of individual who owns a company--a company founded or purchased--that has grown in value over time through extraordinary work and risk taking; a company that is allowing its ownership to enjoy a life style enjoyed by only a small percentage of the people on this earth.

There are many drivers that cause one to think about the sale or merger or refinancing of a business. Among them are:

• Rapid growth requires additional investment for working capital, increasing risk.
• Ownership is of an age that suggests retirement with no kin following in the business.
• Industry consolidation looms, changing the competitive framework.
• The future is more competitive and less certain.

So, how should one think about this decision? First, consider the decision in a perfect world. In a perfect world, your company has a track record of accelerating growth and accelerating earnings. It has positive growth and increasing cash flow. It is a leader in its industry or sector. And its market is large and expanding. The business enjoys good management and owns patents or trade secrets that are valuable barriers to entry.

In this perfect world just about everybody should want your company; but what will they pay, and would you be willing to close a deal at that price? That depends on a number of factors. Generally speaking, valuation theory suggests that a business is worth the future cash flow that the company will generate based on a formula that takes into account the growth rate into the future and a risk-adjusted discount rate to bring the future back to present value. Other indicators of value are comparable company analysis and the implications of minority equity valuation of appropriate listed companies. So what else is new!

Here is a generality that may help: For any given business, at any given point in time, value is greater when the equity markets are higher and yields (interest rates) are lower. This means that at the time this was written, before the markets retreated in 2000, with the equity markets at relative historic highs and a benign interest rate environment, both strategic and financial buyers could be expected to pay more.

This also means that as the equity markets retreat or the interest rates increase, or if both situations occur, your company will be worth less, even if its performance remains unchanged. In fact, to maintain value will require earnings growth that exceeds the downward pressure on values created by the retreating market or increasing interest rates. In other words, working harder may be necessary just to maintain value, even though the company would otherwise be fundamentally the same.

This is not a trivial concept because it implies that timing may be a very important consideration in the sale of your company, even if your company is still a work in process. So why do owners resist selling even though the time appears right? Because buyers, regardless whether they are strategic or financial, can never pay enough to make up for ownership of a successful business cash flow.

Example: Sam owns a technology-based company. The company is presently showing revenues of $100 million with pretax income of 10 percent. The company is an S corporation. Strategic buyers are offering $133 million cash for the company. Sam correctly figures that after some 25 percent state and federal taxes on the transaction, he will have roughly $100 million to invest. At reasonable risk this will yield about $6 million per year--less than the company is presently earning--and he will not be able to participate in the future growth in earnings or value of the company. Sam feels that he could continue to own the business, not pay the tax, and have more cash flow each year. Furthermore, Sam feels that he will always be able to sell the company for $133 million.

What allows Sam to feel this way is his view of risk. He sees no difference between the risk in a sale and the risk in a hold. Therefore, he is attaching no value to the concept of certainty. Even if he is correct with respect to the risk in his business, he really has failed to consider the risk in the other market variables that act on price; namely, the levels of the stock market and interest rates. By holding instead of selling, he may be putting himself into a position of having to run harder just to maintain value. Since all markets are cyclical, if Sam really has no short-term needs for the money, why should he care? Because experience shows that owner-operators regularly overestimate their ability to predict the future, especially the emergence of new competitors and substitutes, and many times leave behind them the best deals of their lifetimes.

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