Valuing a Privately Owned Business
Yes, yes, yes…but what’s it worth? The most common question on the lips of all vendors! Forget everything else, how much is my business worth?
And we know the stock answer is “a business is worth what a buyer will pay and what the seller will accept”. Certainly without that mutual agreement there can be no deal, but surely there must be a way of establishing some basic value?
The starting point for you as vendor must be to establish what the business is worth to you. And you need to take a realistic and practical view. For example, in the smaller entrepreneurially driven businesses, valuation is rarely commensurate with owner’s remuneration. Effectively, any vendor will be discounting their future potential remuneration into a suitable cash lump sum. Thus the reason for sale is of prime importance. If the motivation is to maintain a high income lifestyle then a sale may not even be appropriate. If it is a retirement sale, the desire to realise investment in the business, or for a strategic reason, then a fair deal in the marketplace will be possible.
There is no right or wrong way of valuing a business. Ultimately the market is the only true measure. Much will depend upon the acquirer’s motivation for buying. Some acquirers focus on profit, some on assets and some on cashflows. Certain sectors have their own “rules of thumb”. It is impossible to generalise. However, for the smaller privately owned trading business, there are certain fundamentals.
For most businesses the key issue is profitability. This is the basis on which any acquirer will measure the return from their investment in the business. Profit can be measured in a number of ways but the preferred method is EBIT, “earnings before interest and tax”, because this most accurately reflects future return. Profit also has many guises. The one that matters is “sustainable” profit, which is the true profit an acquirer can expect to derive from the business given normal trading performance. That performance will normally be measured over a number of years, rather than one year in isolation, to even out distortions of trading.
Once sustainable profit has been assessed, the market will apply a suitable multiple to that figure. That multiple will vary depending upon a number of external factors, principally the state of the economy, the attractiveness of the particular sector, the market position of the business itself, and other competitive factors.
But trading and profit performance are not the whole story. “Strategic” and “intangible” value are also important. These are all those features about a business which are not directly reflected in the profit calculation. These may include branding, patents, licences, key contracts and any features which give the business clear “differentiation”. Barriers to entry to the market and the strength of market position are also important, as are a strong customer base, and unrealised growth potential.
Finally, a further important element which is often overlooked is that, as with all things, value is also “in the eye of the beholder”. If the value of your business is “what a purchaser will pay for it”, then the key measure is what several purchasers will pay, in a competitive situation.
A lone purchaser will generally pay as little as they can get away with, whereas best value will always be achieved through competing interest. A key part of any successful sale will always be undertaking comprehensive marketing to uncover those strategic purchasers to whom the business will always be worth more.
So, business valuation is an art not a science. A business can be worth twice as much to one acquirer than to another, and neither will be right or wrong. Ultimately, the deal must be fair to and meet both sides’ objectives.
As with so many aspects of business, in this specialist area, taking proper specialist advice can be crucial in achieving the best possible price for your business.
5 May 2017