“How much is my business worth?” is the one question that I’ve been asked several times recently, mostly by clients approaching the big ‘R’, the date they’ve set for their retirement.
The correct answer, as you might have guessed, is the same answer as when an Estate Agent is asked to value a house, or a car dealer the value of your vehicle; it’s worth as much as somebody is prepared to pay for it.
There is no single formula that can be used to accurately value every private business due to two conflicting forces; the seller wants as high a price as possible and the potential buyer wants exactly the opposite.
Accountancy degree courses teach us that there were five tried and tested standard methods to value most businesses. The 5 standard valuation methods are:
1. Earnings Multiples – This method is suitable for businesses with an established financial history with relatively few or low value assets and is generally calculated as so many times the average adjusted Net Profit over 3 to 5 years.
2. Entry cost – This is the predicted cost to set up a similar business to that being sold. This would include the cost of developing a customer base and reputation, recruiting and training staff, purchasing assets and developing products and services.
3. Asset valuation – This method is more appropriate for established companies with a high level of tangible assets, such as property and pub companies. The valuation is made by either calculating the net realisable value of all assets or by calculating the projected rental income over a 10 year period or ROCE (Return On Capital Employed), with either variant giving a similar valuation.
4. Discounted cashflow – This method uses a prediction of the businesses’ cashflow over a certain period of time. The “terminal value” of the company is also calculated after this period has expired. The value of the predicted cashflow, plus terminal value, is then discounted, to provide a current business valuation. This valuation method is most often used when a company has a lot of potential, but few assets and little financial history to speak of; a typical example would be an online business.
5. Relative valuations – For certain sectors of business, such as recruitment agencies, letting agencies, accountancy and legal practices, when businesses change hands on a regular basis, accepted industry-wide rules of thumb are often used to value them by determining how much similar businesses would bring if they were sold.
One of the main problems in accurately valuing a business is, that whilst there are relatively easy ways to value certain parts of the business, such as stock, fixed assets (land, machinery, equipment etc.), there will very probably be a sizeable intangible element to the value of a business, which is most often shown as ‘Goodwill’. This is notoriously difficult to value, and in many cases will come down to how keen a potential buyer is to acquire the business in question.
Pricing your business, Try to be realistic
Occasionally one of my clients has been fortunate enough to receive an unsolicited offer from a rival firm; indeed it happened to me 3 times. This means that the whole valuation basis is different, but even then there is only so much that buyers will pay. Acquisitive firms, who make the initial contact, often have a tried and tested modus operandi and know their limits, even if their offer is likely be higher than that paid to a seller who initiates the process.
Some of my clients approaching retirement think that they can command a stratospheric valuation, a la dot.com companies, because their business which now brings them in a decent living; has only got to this position because of a lifetime of hard work and sacrifice and they are looking for their ‘reward’.
In my experience too many business owners, having discussed it with their mates ‘down the pub’ generally apply a multiple, typically at least 5imes their Net Profit and add to that a generous valuation of business assets and stock because they think they ‘deserve it’! They are subsequently genuinely surprised when there isn’t a queue of people waiting to snap their hand off.
Use your Accountant’s experience
Accountancy forums are littered with examples of sellers whose business slowly spiralled down because of unrealistic expectations. Asking 5x current Net Profit when the market norm is 2.5x is either greed or living in cloud cuckoo land and buyers walk away, leaving the stubborn owner to wake up one day and realise that it is time to retire and by then he’s missed the boat and has to sell well below market values.
So if you’re thinking of selling your business and have time on your side, better decisions are achieved if you do your research on what similar businesses have sold for and get you accountant to do a realistic valuation.
Starting too high usually means that you’re forced to start dropping the price; which will invariably result in the market soon smelling blood in the water. Selling a business can often be a dark art and certainly not a science. The bottom line is simply this; leave yourself sufficient time and get some professional advice, before putting up the ‘for sale’ sign.
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