Business Valuation

Many owners have a valuation in mind when it comes to their business and, being a corporate finance advisor and owner of wesellanycompany.com, I regularly get asked the question “how much do you think my business is worth?”

A former boss of mine once told me that valuing a business is not a science it’s an art. Ultimately a business is only worth what someone else is willing to pay for it and many business owners believe that their business is worth a lot more than someone else thinks.

As part of qualifying as an ACCA member I learned various equations on how to value a business, such as the Black Scholes method, but when it comes to an SME one of two more simpler methods is usually used.

MULTIPLE OF EARNINGS (NET PROFIT, EBITDA OR TURNOVER)

This is where you calculate a maintainable earnings figure and multiply it by a number. There are several factors which influence this multiple number. This method is usually on a cash free / debt free basis where business cash is added, and debt is deducted from the value.

NET ASSETS

For a business which is capital intensive, for example has a reliance upon high valued equipment, a fleet of machines/vehicles or safeguarded intellectual property, a net asset valuation is likely to be used. This is where you take the balance sheet net assets figure and add an amount for goodwill (usually a multiple of profit).

MULTIPLE FACTORS

There are several factors you need to consider when determining if a business has a low or high multiple – both in terms of the earnings multiple and the goodwill valuation. The following represent some of the key things that are considered:

Management team – a lot of small businesses have a heavy reliance upon the owner and in some scenarios the owner is in fact the business. This makes it difficult to place a high value on a business because a lot of the goodwill is with the current owner. A business which has a management team in place capable of managing it without the current owner is more likely to have added value and be more attractive to a potential buyer. If you’re a business owner, the key question to ask yourself here is “Can the business survive or maintain performance without you?” If the answer is no, then now is probably not the best time to sell if value is of importance.

Customer concentration – a business whose turnover has a heavy reliance upon a small number of customers is less attractive than a one which is widely spread amongst several. If a business has 75% of its income from one customer there’s a risk that losing that work will diminish the turnover, profits and value of the business. I once did a review of a valuation which was prepared for divorce proceedings and a value of £1m had been placed on a business whose turnover was generated from one customer with whom there was no long contract in place. I recommended that this valuation was contested, and the client won the argument in court……the business lost the work a few month later, went into liquidation and the client saved paying their former partner a large amount of money for something that was ultimately worth nothing.

Recurring revenue – a business which can demonstrate recurring revenues from customers is more likely to attract interest and a higher valuation than one which has lumpy or unpredictable revenues. Having longer term contracts in place can provide security that these revenues are going to continue and therefore give confidence in the turnover/profitability to potential buyers. One thing to consider if you plan on selling your business is to make sure contracts with customers do not have a change of ownership clause in them which allows a contract to be cancelled on the transfer of the business to new owners.

Multiple arbitrage – business owners may read in the news that some large businesses or shares on the stock exchange are being traded with valuations based upon earnings multiples over ten or twenty which then gives smaller business owners the perception that theirs is also worth these kinds of ratios. Unfortunately, due to what is termed as “multiple arbitrage” a smaller business is likely to attract a much lower multiple than a large company. For example, a business with Net profit of £1m may attract an earnings multiple of 4-6 whereas a business in the same industry which generates profits of say £5m may attract 9 or 10 times multiple. In fact, some private equity houses acquire several smaller businesses in the same industry paying say 4-6 times profits, group them together, do not operationally make many adjustments, and sell them as a collective larger company for the higher multiple a few years later. A sell side advisor may consider this, when negotiating the sale of a company when the buyer is a bigger organisation, in order to increase the sales price.

CONCLUSION

In conclusion, a business advisor like myself can do a business valuation report for dispute, divorce or borrowing purposes but ultimately when selling a business, it is only worth what someone is willing to pay and by taking certain steps and “grooming” the business for 2-3 years before selling you can make it more attractive and more valuable. Therefore, it’s best to seek advice early when you’re planning to sell your business rather than wake up one day and deciding to market it for sale.

Barry Gill, Founder and Managing Director of WeSellAnyCompany.com

Barry Gill, Founder and Managing Director of WeSellAnyCompany.com