Putting a dollar value on your business can be challenging for many owners. After all, how is it possible to price years of blood, sweat and tears?
However, whether due to retirement or other reasons, the time may come to sell and it is important to have a valuation in mind before launching the process.
Traditionally, the valuation formula is a multiple of profit, typically earnings before interest and tax (EBIT), although in some industries it is a multiple of revenue, value per member or client.
Such multiples are usually established across a particular industry based on past sales, reflecting the risk or volatility of the industry and its growth prospects. A service-based business may be valued as low as one year’s earnings, while an established business with solid profits could sell for up to six times EBIT.
Another valuation model is based on discounted cash flow, with the net present value calculated by applying a discount rate to future income streams. Under this formula, reducing the discount rate (risk) and increasing the certainty of future earnings results in a higher value for the business.
Capitalised future earnings calculates value based on the average net profit over the previous three years, divided by the buyer’s expected rate of return and then multiplied by 100.
Examining recent sales of comparable businesses can also provide a guide to value, with such evidence obtainable from business brokers or ‘business for sale’ advertisements.
Another method, net tangible assets, values only business assets such as property, plant and equipment, with no value attributed for goodwill or intellectual property. However, this method is typically only used when a business is being liquidated.
What the market will pay
“People look at turnover, profit and the balance sheet, but ultimately it’s what the market will pay, like in real estate,” says Peter May, an experienced CEO and marketing consultant at Xavca Pty Ltd.
“It could come down to intangibles like brand awareness, reputation and image, so you need to lock in sales via contracts and service arrangements, anything to establish you’re getting repeat business, which gives the buyer confidence they will get that business again.”
May says owners need to show strong knowledge of their client base – “who they are, where they are, what they like and when” – to boost the sale price.
“If you’ve run your business with good customer records and you know who your customers are and what they spend, that’s valuable information that supports the financial statements and gives confidence to the new owner.”
Reliable earnings growth
KPMG partner Phillip Walker says growth is the “single most important factor in multiples” with buyers willing to pay more for higher-growth businesses as well as those with stable earnings.
He also says business owners need to show robust management practices, including an ability to transition customer, supplier and staff relationships across to the buyer.
Owners also need to maintain appropriate financial records, including budgets and forecasts, as well as having ownership of the relevant intellectual property such as logos and trademarks.
Finding the ‘right’ buyer can also boost the value of a business, if the owner can show how a larger company could maximise profits and revenues based on its greater resources.
While beauty may be in the eye of the beholder, valuing your business successfully requires the right mix of financial and customer data along with the right buyer.
This article represents the views of the author only and not those of American Express.
Anthony is a communication consultant at BWH Communication and a freelance writer with 15 years' experience in the stockbroking and media industries of Australia and Asia. He is a regular writer on business and other issues for publications in Australia and Japan. He consults on communication strategy to businesses ranging from private enterprises to professional service firms and publicly listed companies, with a particular interest in entrepreneurship in all its forms.