After spending many years building a company that has provided a comfortable living, the owner expects to be able to sell it for top dollar. As we have written previously, however, company valuations are dynamic, are often out of the owner’s control, and are based on a multitude of factors. With that said, is there ever a scenario in which the owner might consider selling their company for book value?
Essentially, book value is total assets minus total liabilities. It is also commonly referred to as “net worth.” Book value specifically excludes goodwill other than goodwill that was acquired through an acquisition. Book value may coincidentally be the fair market value of the company based on various valuation methodologies. However, book value is often used as one valuation approach for companies that have significant tangible assets, but generate a low net income. In this case, the return on net worth (net income / net worth) is low. In fact, there may actually be negative goodwill (the fair market value of the company is less than the book value of the company) in order to increase the return on net worth.
If the owner is seeking an exit that will generate the highest proceeds and if the business is not generating significant earnings and cash flow (negative goodwill), an orderly liquidation of the business, i.e., terminating operations, collecting accounts receivable, and, in a series of transactions, liquidating the tangible assets (inventory, property and equipment, etc.) and the intangible assets, if any, may generate the highest gross proceeds. The gross proceeds from the liquidation can then be used to satisfy the company’s debts (accounts payable, loans payable, etc., and liquidation costs). For example, a company might have $1 million in earnings but have a $20 million book value.
In this case, it might make more sense to base the company’s valuation on book value because the liquidation of the assets net of the satisfaction of liabilities may result in a better outcome for the owner than a sale based on the company’s earnings and cash flow, i.e., a going concern sale.
Notwithstanding “accounting” book value, book value may need to be adjusted to reflect the current fair market value of the company’s assets in order to establish the proper expectations from the liquidation of the assets. These adjustments may be made to:
- Accounts receivable to adjust for inadequate provisions for bad debts;
- Inventory to reflect obsolete or slow moving items that have a sale value lower than book value;
- Property and equipment that has an appraised value that is higher or lower than the depreciated value;
- Loans receivable that are not collectible or are not collectible at book value, and therefore must be written off or written down.
While liquidating a company for book value in some cases may seem like an attractive option for the owner, there are many attendant risks involved in doing so. For starters, how does the owner go about liquidating the company’s so-called valuable assets, and what is the cost to do so? (Hint: there’s always a cost.) Moreover, what will those assets actually be worth and what proceeds will be realized when they are liquidated — will they fetch the proceeds that the owner is expecting or will they end up being sold at a discount, causing the owner to fall short of their objectives?
Furthermore, when the company’s customers no longer need the company’s products or services, will they pay their receivables, or will they need to be compromised or written off? What about the employees? Are they unionized? Are WARN (Worker Adjustment and Retraining Notification) Act laws a factor, and does the owner need to provide at least a 60 calendar day notice in advance of a business closing or mass layoff? Is the company a party to a multiemployer pension plan with a withdrawal liability? Finally, let’s not forget about the time to achieve the liquidation, which can extend for years, and the effort to liquidate the company.
As inferred above, liquidating a company is not an easy task and is fraught with uncertainty. That $20 million book value that the owner thought they would receive as a result of the liquidation may dissipate quickly as it gets eaten up by deductions due to write-offs, liquidation and employee costs, environmental issues that may need to be remediated, and other unforeseen transaction-related expenses. As such, the expected liquidation value can quickly become less-than-ideal and generate less than the expected net proceeds. The takeaway: selling a company as a going concern, even at a price that is less than accounting book value or adjusted book value, may make sense after all, after accounting for all of the deductions to book value and considering the time and effort to achieve the liquidation.
To be sure, liquidating a business to try to realize book value may be a viable option for an exit and may achieve higher proceeds than a going concern sale. With that said though, this type of transaction has its pros and cons, and the latter often outweighs the former if the liquidation is not well conceived and executed. Ideally, the owner will have the time and foresight to prepare their company for sale in advance so that they can orchestrate a going concern exit when the time is right, or, as we often say, “when the stars are aligned” rather than seriously considering an orderly liquidation.
Hiring a business advisor well in advance of the desired exit may help the owner create an exit that achieves the owner’s desired objectives, along with avoiding the risks and pitfalls of liquidating their company for “book value.”
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