Valuation of a business

I was talking to a business owner recently about the value of his business, now and in the future. 

There are various ways to value a business, but all are irrelevant if someone is not prepared to pay that amount.   When looking at the value of a business, we look at the intrinsic value, whether people would be prepared to buy and what they would be prepared to spend.  Of course, there is no accounting for folk and people often surprise me with the decisions they make so all is theory until you have the money in the bank. 

Businesses are usually bought for the future cashflow and profit potential.  The buyer will have seen a way of making more money from running that business themselves, or disposing of the assets themselves, than they have had to pay out.  

Ways of valuing a business:

Asset Stripping

What assets do you have in the business and what are they worth? Fundamentally, if you closed up shop today what could you convert into cash, often called a “fire sale”. 

Most of these assets will be shown on the balance sheet, but probably not at the cash value.  Fixed assets may have been purchased many years ago and depreciated through the years.  There might still be value in them, and a good depreciation policy should have ensured that that was reflected in the carrying value, but in our experience, this is unusual.   Intangible fixed assets around goodwill, brand recognition and intellectual property, such as patents, trademarks, and copyrights, may all have a value that is hard to quantify until someone tries to buy.   Companies have been brought and sold for substantially more than the carrying value of the asset if a competitor or other interested party needs the patent, copyright or licence to fulfil their own ambitions. 

Current assets such as stock and debtors will need to be revalued if the business in question is not being continued.  Will you need to reduce the stock value to sell?  Will all your customers be persuaded to settle the full amount of debt if they are not trading with you going forward?  If you are selling the business as a going concern, will these go with the buyer or remain with the seller?

Multiple of turnover

Accountancy practices are generally valued as a multiple of turnover and depending on market conditions can be anywhere from 0.8 – 1.4 times turnover.  Fee income for accountants is relatively stable full of repeat business, if the new owner buys the fee bank, does a reasonable job and gets paid, he is likely to retain that client for a couple of years at least.    This model works as most accountants would understand the business model and would be prepared to subsume the work into their existing team structure.  It does not work with most industries where turnover is more subjective and profit percentages variable and dependent on many factors.   

Multiple of profit

If we look instead at multiples of profit, an outside entity may have difficulty determining the true profit from the accounts.  Financial accounts are not prepared in such a way that the true profit can be instantly ascertained.  To get a true valuation of a business, we need to find the adjusted net profit which accounts for extraordinary or special items.  For example, where businesses have been owner managed the owners’ wages need to be adjusted for market rates, whether that is to be increased as the owner has been under paying himself or deleted as their work can be taken over by the buyer’s team.  

Adjusted net profit multiples for valuation purposes can range from 1 – 10 times Adjusted net profit.

Items that will affect the multiples include:  

• The owner is an integral part of the running of the business and the business could not survive without his knowledge and expertise and relationships with key stakeholders.  We see this in consultancy businesses or in businesses where the owner has been made the hero of the business story to such an extent that no-one will deal with that business if not served by the boss.  
• Where the business is reliant on a small number of key stakeholders, whether that is clients or suppliers.  In those cases, the fate of the business could be influenced by factors outside of the buyer’s control. 
• The profit margins are very tight or consistently small than industry averages, any change in the way the business is managed could adversely affect those margins. 
• If team turnover is high, buyers could be wary of the management practices within the business and worry that key knowledge will be lost after buy-out.
• If the business can prove that it is well run and thoroughly systemised, it will attract a higher multiple as potential buyers can forecast future profits reasonably well. 
• Where a business has long-term contracts that allow reasonable estimates of turnover and profit to be established.  This can work against the sale of a business if remuneration has been front-loaded as any buyer will need to fulfil the contract without the benefit of any income. 
• Is the business well run, the accounts in order and all compliance requirements adhered to?  

 Any uncertainty or perceived uncertainty in the business will bring down the valuation.  

Mixed Valuation

There may be a mixture of both profit multiple and asset valuation in the valuation of your business. If there are assets that are owned by the business but will not be used in the business once the sale is complete, these can be sold separately. If you own the premises for example and you are selling to someone who has spare capacity, they may move the business to their own location, and you would be able to sell the premises you own.  There may also be intellectual property or rights that would fall into this category which you may wish to keep or sell separately to the main business. 

Increasing the value of your business

It takes around 5-10 years to prepare a business for sale, but the process can deliver two key benefits, the first is an increased value, possibly as much as from 1x to 10x, the second is that on the way, you will have more fun in your business and make more money.  

• Fix any problems with the basics in your business, make sure that customers are getting a consistent service or product, that your bookkeeping is in place and your accounts are in order, get control of your time and your team’s time.   
• Have a clear vision for the business, with a clear message of what you stand for and why, of how you work with key stakeholders and what is driving the business forward.  This will attract notice, and position you as great in your marketplace.
• Know how to market your products and services, what works, what doesn’t, track and measure your marketing and know how to turn on the lead generation tap anytime you want to. 
• Have processes in place for everything, from the way you answer the phone, to how you do the work, to how you hire great people.  Get the system out of your head and into the business infrastructure.
• Hire great staff and lose those that are not on the same bus as you. Be prepared to allow people to take risks and push the business forward.  A business with a great work culture will have a higher perceived value. 
• Ease yourself out of the day to day running of the business by building a strong management team.   Test this by taking a holiday, if your business cannot run without you for 2 weeks, how will it survive when you sell it?

Ultimately the value of your business is up to you.  Put in the work to build a great business and you will be paid twice, once as you trade and again when you sell.   Or sell now and take a lower price.  The choice, as they say, is yours.