While maintaining ownership insulates companies from many concerns, the stock market still has an impact on private business value.
In the wake of recent stock market volatility, many owners have questions about the market’s impact on the value of their business.
Owners of privately held companies avoid going public for many reasons. The primary reason is most private businesses are too small to be public. Of those private businesses that have sufficient size, many owners want to avoid the loss of control that comes with adding new shareholders who will inherently expect the business to meet specific growth and revenue targets. Others want to avoid the increased regulations that the SEC and other agencies require of publicly traded companies.
While maintaining ownership insulates companies from many of these concerns, the stock market still impacts private business value. This post explores connections between private business value and the stock market, and provides insights into strategies to mitigate the impact of market fluctuations on business value.
Privately Held Businesses Are Protected from Some Market Volatility
By definition, private businesses are disconnected from the public markets. Even if the market doubles, an investor isn’t likely to pay double for a private company.
Stock prices, and thus public companies, are valued on a second-by-second basis. For privately held companies, if valuations are conducted, the expectation is the result is valid for at least a few months and maybe a year. Private companies are inherently subject to extremely long holding periods. Many private companies are simply not salable. The longer holding period mitigates the daily price swings that occur in the stock market. By taking a big-picture view of a business, public market high and low swings average out, ultimately generating a valuation that is directionally accurate but does not reflect daily peaks and valleys.
Private Business Value Follows The Public Market
Public market price movement will directionally change the value of privately held businesses. For example, a down market creates two impacts: the first is the obvious price decrease; the second is the purchasing currency (public stock) is now more scarce, so less-desirable transactions will no longer be pursued. Lack of pursuit during market downturns leaves private businesses less marketable and much harder to sell. Investors in a down market have less competition and more investment opportunities so are less likely to make a strong offer.
If a business needs to sell in a down market, sale price reduction may be the only tool available to get a transaction completed. This price reduction should be reflected in the business valuation (which reflects the price someone will pay on the open market). So it is not realistic to believe that owners can sell private businesses at a reasonable value when they retire.
Market Growth Can Also Decrease Business Value
While it may seem counterintuitive, market growth can also decrease the value of some privately held businesses. Market returns provide a benchmark that investors will consider when buying a company.
Regular growth is important for the success of a business, but what owners consider a strong growth rate may not look strong to investors. If the business is growing, but at a lower rate than publicly traded companies, then investors are much more likely to invest in publicly traded companies. For an investor, a business is desirable when it is growing more than the stock market peer group.
Increase Value Through Sound Business Practices
The successful sale of a business takes significant long-term planning. Investors who want to purchase a business will typically require detailed reports on projections, margins, and other financial details. Many business owners are unable to provide the level of detail that buyers require. Owners often juggle many responsibilities, and it is easy to deprioritize regular, detailed financial accounting. But buyers expect this information and often will not purchase a business without it. If they purchase without detailed information, it is at a material cost to the seller.
Owners who are able to prioritize this recordkeeping and reporting will be more likely to sell in the future. In addition, better record keeping supports better decisions. Be prepared to verify your financial results. Trust is not good enough here.
The best way to increase the value of a business is to improve business fundamentals: increasing profit, decreasing risk, and maintaining growth.
Adams Capital has experience in helping privately held businesses increase value using smart, forward-thinking strategies. We offer a no-cost initial telephone consultation to business owners looking to establish themselves as the benchmark that competitors measure themselves against.
To begin a conversation, please email Tara at tara@adamscapital.com or call us directly at 770-432-0308 to schedule a consultation.
Author
David Adams is the President of Adams Capital, LLC. He is an expert in the valuation of businesses, business interests, and tangible and intangible property for mergers and acquisitions, corporate recapitalization, privatization, gift and estate tax planning, bankruptcy proceedings, dissenting shareholders, Employee Stock Ownership Plans, and financial and tax reporting. Frequently counseling business owners and families on methodologies to enhance shareholder value.