How much is your business worth?
If you are thinking of selling up, what could you get for your business?
lets look at some factors involved in valuating the business.
The most significant influence on the price you will get for your business is the Law of Supply & Demand. If, when you sell, there are plenty of buyers with ready cash and few sellers, you will get a reasonable price. If the converse is correct, you will either not get a reasonable price or even worse; you may find you cannot sell up.
Generally, people do not buy a business for what it is; they will buy for what the business does for them. Namely earn them cash to repay their investment, provide them with a living, and build for the future. With cash (not profits) uppermost in their mind on the first two of these, the price is often based on something called ‘EBITDA’. EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation) is an accountancy term that represents the sustainable cash profits of the business assuming nil borrowing costs.
To value the business, multiple is applied to EBITDA. The Law of Supply & Demand essentially dictates the various for a business sector, or any part of it, or any specific firm.
There is no universally agreed multiple in a industry, or firm, and multiples vary widely between and within specific sectors depending on several factors, but principally the certainty and size of the future cash flows of the business. The multiple applied to your business will depend on a combination of factors; we go into some of these factors in detail below.
Pricing a business is thus more of an art than a precise science. It is not merely a calculation based on two predetermined numbers, and valuers, purchasers and vendors often arrive at differing figures. At the end of the day, it is you who must be satisfied that you have got the best deal under the circumstances.
To get the best price, the main issue you should concentrate on is timing. When the business is ripe for sale, it is often not the right time for you personally, or there are too few purchasers with ready cash.
All other permutations apply, except the one where all the circumstances fit together neatly. Consequently, selling your business generally involves some form of compromise. This makes the decision more difficult for you, especially if you are emotionally tied to the business.
There is always a lot going on in the business when you sell, negotiations are intense, and feelings high: selling is a stressful time for you. So it is essential that you plan how you are going to sell the business. Only by doing so will you maximise the price you will get. When planning, you should bear in mind the following:
Discover the full guide on buying an existing business.
SIZE OF THE BUSINESS
Forget the old maxim, size is essential. Large firms attract more significant multiples and more interest than smaller firms because they are perceived as being less risky. Larger firms are less likely to fail and are less reliant on the owner’s involvement. Your firm, however large it grows in its niche or how profitable it becomes, maybe too small to attract the right purchaser, namely the one with cash. Thus, ignore the price achieved for one of your more significant, more inefficient, competitors: you may never make a similar multiple; however, right your business is.
Growth prospects are one of the more major factors affecting the multiple. Buyers will pay more for businesses with higher growth rates as they repay their initial investment quicker than those with low or no growth. Consider selling up before turnover or profits have levelled out. This may go against the grain where you have put in place the basis for such growth, but increasing the multiple, as opposed to expanding the EBITDA, will have a more significant impact on the price you achieve.
THE BUSINESS PROFITABILITY
High gross margins and proper levels of cash generation from profits give buyers more flexibility going forward and reduce the risk of the investment proving bad. Buyers will pay more for businesses that consistently report better than industry average figures.
However, the fact that you operate an extremely tight ship may put a buyer off paying too high a price. Buyers will look for easy wins/cost savings, so if a buyer identifies areas where he can make significant efficiency savings or growth that could make your company more valuable to him. It is often worthwhile specifically targeting potential purchasers able to achieve such synergies.
Some sectors attract better multiples than others. There are a number of reasons for this: fashion (such as the dotcoms, energy businesses etc.); estimates as to future growth prospects; robustness at times of boom and bust etc. In general, the more positive the future cash flows of a sector, or company, the higher the multiple.
However, some niches within a sector can command a premium from time to time, depending on the then demand for the product/service. Building a ‘sustainable competitive advantage’ and ‘Unique Selling Point(s)’ in a small niche can produce an attractive price at a time of boom in that sector generally and a better than average price when times are bad.
Diversification, although often reducing operating risk, does not always add to value: it can reduce the value of the overall business. Buyers may only be willing to take on that part of your business that fits in well with theirs; they could either discount the total price, leave you with the part they do not want or, in the worst case, you could find your business un-saleable. It may be safer to stay in a part of the sector, especially for smaller businesses, as it can be challenging to find a buyer who will appreciate diversity.
The quality of your customer base is one of the main factors influencing multiple users. Customer bases made up of blue-chip clients in growing industries attract higher multiples, mainly if there are opportunities for the buyer to sell additional services into them. If specific customers, or customers in a industry, make up a large part of your business, it will affect your pricing, because buyers will see you as having too many eggs in one basket.
Another critical component is the strength of the balance sheet. Once buyers have bought a business, they want to focus on growing it and integrating it into their organisation, rather than deal with historical balance sheet problems.
Buyers will assess the former owner’s management of working capital. Businesses with a history of good cash, debtor, and creditor management attract higher multiples than those with a poor track record.
Other balance sheet factors that can influence a firm’s value, such as the amount of bank/factor debt, and any impending litigation.
It is essential to many buyers to retain the owner, at least for some time, to help introduce them to customers and make sure staff are comfortable with the new regime.
Often a buyer will agree to pay an incentive (this is termed an ‘earnout’) to the owner to encourage him to stay and to seek to avoid bearing the entire risk of the acquisition. Buyers often look to pay the former owner a share of profits earned over a two- or three-year period.
Earnouts can constitute a significant part of the purchase price. The smaller the company, the more uncertainties there are that could affect how the business might perform, and thus the more likely it is that the buyer will seek an earnout. With planning an exit taking up to two/three years, and the earnout a similar period, it could be five years before you can book your sun lounger fulltime.
Earnouts is one area where your advisers earn their money. Earnouts create conflicting interests between the current and former owners of the business; there is a risk that the buyer will look to reduce or defer profits to minimise the earnout paid.
The previous owner will seek to maximise profits and hasten their recognition. With the former owner having little or no influence post-sale over strategy, accounting policies, expenditure etc, there is a genuine risk that he could receive less than initially envisaged for the business. It is essential that your advisers protect your position wherever possible.
There is a balancing act to be struck; you will have to decide how much money you are willing to wait for and form your view of the risks involved based on the likely future profitability of the business and your assessment of the purchaser, as against accepting a lesser, but more certain, sum now.
At the end of the day, any business is only worth what you can get for it at the time you sell it. A mathematical calculation of value is a mere indication of potential worth, a discussion tool to be used during the negotiation process.
Confidence levels set the level of demand for your business, and in turn, how much purchasers may be willing to pay for it.
While any downturn will ultimately affect multiples, to get maximum value and increase the certainty of a sale, it is more important than ever that owners considering selling prepare and position their business ready for sale early, and that during the sale process is carried out in such a way as to target purchasers with the right fit, hunger and cash to complete a deal.