By Gareth Smyth, Group Managing Director of Hilton Smythe
There are many reasons why you should consider valuing your business. The most obvious is if you are selling, or if you are splitting from a business partner and need to know the value to buy them out. Whatever the reason, you should consult a professional valuer, like a business broker, to help. I will talk you through the approaches they will take, as well as spelling out some of the pros and cons of business valuation.
There is a phrase in our industry, ‘a business is only ever worth what someone is willing to pay for it’. Well, in my opinion this is absolutely correct. If there isn’t a buyer out there willing to pay the price of the business in question, then it simply isn’t worth what you’re asking for it. That said, if the valuation is for a loan or security purposes, whether a buyer is out there who is willing to pay a particular price, can only be determined from historic transactions for broadly similar businesses. This is called comparable evidence. It is essential to remember that the valuation is only ever a starting point for negotiations to commence.
I think it is essential that you know well in advance, preferably from the beginning, what your exit strategy is going to be. If you want to sell the business in the end, then build it with selling in mind, regularly assessing its strength and growth by its sale price. This is essential to achieving maximum potential when selling.
I am often asked when the best time to sell is. Frankly, I couldn’t honestly say, except when you are prepared and ready. Too many sellers go to market ill-prepared for sale and they never achieve maximum value.
There are a number of ways to value a business, depending on the buyer and the industry norms. For the purpose of generality and application to a broad spectrum of business types, we will focus on two areas of valuation: EBITDA Multiple and Asset Value.
Earnings Before Interest Tax Depreciation and Amortisation (EBITDA) works with the businesses operating profit or net profit before any tax or interest charges are deducted.
Depreciation and amortisation are accounting principles that allow the writing off of tangible and intangible business assets on the balance sheet. The assets are broken down to represent an annual cost of the particular asset based on its perceived operating life. For example, a company van that is bought for £25,000 and perceived to last 5 years will be charged to the balance sheet at £5,000 per year. It is worth noting that one off and exceptional costs should always be added back in to EBITDA too.
An EBITDA multiple is exactly what it says; taking the EBITDA figure and multiplying it to get an accurate valuation figure. It is possible to see a wide range of multiples used in business valuation, but for the majority of small, owner-operated businesses, you would be looking to achieve between one and three times EBITDA. A good broker can share actual sale prices and multiples with you which means you know the price you are asking is a good starting point.
Where the assets of the business are worth more than the EBITDA multiplied sum above, it would be unrealistic to use the multiple valuation method. Instead, the value is in the assets, so you would want to sell them for their current value.
If you are a limited company, there are certain things required to prepare for sale, such as reconstituting your balance sheet to bring the actual value of fixed assets up to date to reflect the market value, rather than the artificial depreciated value that your accountant may hold.
If you are a sole trader or partnership, you will simply need to make sure you know the value of your assets and ensure they are free from any encumbrance, namely finance agreements or other restrictions.
In reality, a sole trader or partnership could value the assets themselves by looking online to get valuations of similar assets. You may achieve a small premium for the fact the business is in situ and trading so again, seeking advice is key to achieving the best value.
Top Tips for success:
Build your business with selling in mind.
If you intend to sell, don’t leave it until you’re ready to take the plunge to prepare the business. It can take about three years to properly prepare for sale. Too many business sellers are ill prepared for sale and, guess what? They lose value!
Don’t make yourself indispensable
An owner that does all of the work is, by all accounts, the whole business. If you have staff, use them wisely and try to build an operation that could easily function without you. The more reliance the business has on you to succeed; the lower the value will be.
Accounting for the tax man
I often hear that accountants keep the books in the best possible way to save tax. This approach results in lower stated profits. If you are making money, then why wouldn’t you pay the tax that’s due? Whatever your stance on this topic, the more you can show in the bottom line in the few years leading up to sale, the better and the more you will get at sale. If you’re not prepared to do that, be prepared to take less when selling. It’s that simple.
A good advisor is essential. Someone with experience in your sector and who has handled the sale of similar businesses. If you instruct professional advisors, check the terms and conditions, because all too often they contain cancellation clauses. Also, don’t be wowed by an overly generous asking price. Check the market and see what else is for sale to compare pricing, and never be afraid to ask for real examples of sold prices.