My river running friend would have lik to pay 1 million for a business with 1

My river running friend would have lik to pay 1

This preview shows page 118 - 120 out of 263 pages.

few years’ worth of earnings. My river-running friend would have liked to pay $1 million for a business with $1 million of annual cash flow and get out of the risk of losing his money in one year, but like the lemonade stand owner, the owner of the river-running business wasn’t stupid. The seller knows he’s going to get this year’s million-dollar earnings with a high degree of certainty, so if he can’t get more than $1 million for the business he’ll just keep it. But when $5 million was flashed in front of him, it was enough to get him to let go and move on. Knowing why the seller of a private business will take $5 million in trade for an infinite annual million bucks is an important part of knowing what to pay for a business. The seller is getting a million a year from earnings, and he thinks it looks solid well into the future. But consider his risk: He knows there’s no guarantee people will show up next year to go down the river. A drought could empty the river. A recession could cut into vacations. Gas prices could get so high people couldn’t afford to get there. Someone might drown on one of his tours and the Park Service could pull his license (or give him a really bad
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reputation). Or maybe the Sierra Club lobbies the Park Service to cut the number of trips he can lead. People who own even great private businesses sometimes sell because they want to retire or cash out outside owners. For this river-running business owner, getting $5 million cash meant he could pay off his two partners, get rid of a big personal debt, and still have enough to go sit on a beach in Margaritaville for the rest of his life and never work again. For him it was compelling to trade his at-risk future cash in exchange for no-risk cash at that $5 million price. The range of Payback Times for private businesses is from three to ten years, with eight years as the average for venture-capital deals, and about six years for smaller deals. Things are different when you buy public stock, because your investment is liquid—since it’s actively traded, you can sell almost instantly. If you’ve made a mistake, or things start to take a turn for the worse, you can get out and cut your losses. This holds true for the Big Guys as well: they may not be able to get out as quickly as we can (because the Big Guys are dealing with so much more money and shares that they have to sell off in chunks rather than all at once), but they can get out. At least theoretically. That’s worth a lot. And you can see exactly how much that liquidity is worth by looking into those average PEs and Payback Times. The value of the liquidity of a public business gets translated, on average, into about double the price the same business would fetch if sold privately. Payback Time for a public company averages thirteen years, and can go much higher because the buyers aren’t really worrying about how long it will take to get their money off the table.
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  • Spring '20
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