Business Valuations
We look at the why, the how and the when of valuing your business, something that can be a transformative experience for business owners.
THE WHY
So much resource goes into business, quite rightly business owners are looking for a return on their investment. That hopefully comes in the form of profit but sometimes the other opportunity for return is totally ignored and an opportunity missed, the opportunity of creating a saleable asset.
What is more, very often the process of creating a saleable asset is exactly what is needed to create a profitable business. A saleable business has scale, it has strong systems that do not rely on any one individual, it is functioning reliably in all departments of marketing, production and operations
Not seeing these benefits, the business owner allows their business to be an extension of themselves, reliant on their skills, time or commitment. Usually the person who suffers most is the business owner.
THE HOW
There are two professions that regularly provide business valuations: accountants and business brokers. It is worth understanding the difference in the valuations they give.
Accountants are trained in valuing business in terms of return on investment. The valuations benefit from being dispassionate but in comparison to business brokers, they lack knowledge of the market. A business broker is dealing in business sales, therefore they have the knowledge to go beyond theory and reflect the market.
Whichever party is sought to value your business, however, they will start with some tried and tested formulae for business valuations:
EBITDA x multiple
EBITDA is defined as Earnings before Interest, Taxation, Depreciation and Amortisation. It is a calculation that starts with Net Profit taken from a company’s accounts and adds back Interest, Taxation, Depreciation and Amortisation. Typically figures are reviewed back over a number of years to arrive at an average with more weighting given to more recent years.
The EBITDA is then multiplied to arrive at a price. Multiples vary and for valuation purposes the market is reviewed and an average multiple applied compared to similar businesses.
Sustainable Profit x multiple
Sustainable Profit is defined as EBITDA less any exceptional income or expenditure plus any unsustainable discounts.
Exceptional (sometimes called Extraordinary) income or expenditure is income or expenditure that is seen as a one-off and not predicted to continue that would, if left in the profit calculation, distort the picture of sustainable profit.
Unsustainable discounts factors in expenditure that would normally be expected. This is especially common in small businesses where the business owner provides services or space at a discounted rate.
For both EBITDA and Sustainable Profit valuation, the multiple is derived by reviewing multiples offered on the open market. Typically these will be in a range and it is understood that asking prices will typically be higher than sale prices. A typical mutiple would be 3 - 5 times profit.
EBITDA will clearly be favoured by sellers and Sustainable Profit by buyers.
Discounted Cash Flows
Discounted Cash Flow takes a prediction of future cash generated from trading profits and applies a discount to the cash that adjusts for inflation and the risk of trading not achieving the profits predicted. Mostly this method is only used with larger more established businesses.
Equity Valuation
Equity Valuation looks at current assets (cash in bank, trade debtors) and liabilities (loans, tax owed) and assesses the value of the net assets. It is often used as a back-stop, the minimum value below which the business is worth despite low profits.
Whatever the valuation method used, it is important to understand that the valuation it spits out is simply a starting point. Ultimately the value of the business will be found in a negotiation between buyer and seller. What may be valueless to one buyer may be invaluable to another. That said the value will be in the following areas:
Profit
Assets (tangible and intangible)
Growth
Sustainability
All of this will be uncovered in a process called Due Diligence where every aspect of the business and the risks to the buyer's investment will be examined.
THE WHEN
It is never too early to start thinking about the value of the business you are building, it will lead a business owner to build the business in a different way. Once a business is making sustainable profits, it will have value whatever the scale. At that point we believe it is well worth getting a simple valuation even if there is no intention to sell.
