So just how much is your business worth?
06 Jul 2015
You have worked hard all your life to get to where you are now; the business is doing well, it has afforded you a certain lifestyle however you feel that without your presence things just don’t happen. This leads to you putting in longer hours, feeling frustrated that at this stage you are unable to free yourself from the day to day operations; you begin to wonder about how you are ever going to deliver on that dream retirement, the long awaited adventures, the return on your life investment?
So this business that has consumed you and your family’s life for so many years, what will it be realistically worth when it’s time to retire? How will you sell it and for how much? Even if you decide to keep it in the family through a succession plan you would still like to release equity so as to enjoy the fruits of your labour, but how? What is your exit strategy?
Considering you are still a critical part of the business I am afraid that unless you change how the business is run then you will most likely get a lot less for your business than you expect. To turn this around and maximize the worth of your business you need to:
1. Extract yourself from the running of the business as much as possible; remember a potential buyer will be far more receptive to pay a premium for a healthy business operating under management showing consistent profits and growth, than one where they are really buying a job.
2. You will need to change from a tax minimization strategy to a tax maximization strategy at least two financial years before you would like to sell, thereby demonstrating further the real returns for a potential investor (normalisation of earnings).
3. Put your plan in writing and have a plan B and a plan C. Things don’t always go as planned. It is always smart to have an alternative plan; such as a way to offer seller financing or alternative ways to identify buyers. It is also wise to identify your potential acquirersexit options as early as possible.
4. legal and accounting advice and prepare yourself for your exit. Unfortunately many business owners fail to prepare their business for sale and thus give away much of the possible sales value. It is amazing how much some owners leave on the table or give themselves a totally un-necessary tax bill that could have been solved or vastly improved with a little foresight and planning.
5. Communicate with key stakeholders when and if you think it is appropriate (clients; suppliers; staff; bankers etc.) as all have a vested interest in a successful sale.
So, where to start?
Valuation is the process of estimating the monetary amount that a business is worth based on future expected returns. Valuation is the function of risk and return.
We have below tried to articulate the basic science and maths behind the most common business valuation techniques, but keep in mind that there will always be outliers that fall well outside of these frameworks. These are strategic sales, where a business is valued based on what it is worth in the acquirer’s hands. Strategic acquisitions, however, represent the minority of acquisitions, so use the three methods below to triangulate around a realistic value for your company:
The most fundamental way to value a business is to consider the value of its hard assets less its debts. Imagine a trucking company with trucks and various equipment. These hard assets have value, which can be calculated by estimating the resale value of your equipment.
This valuation method often renders the lowest value for your company because it assumes your company does not have any “Good Will.” In accountant speak, “Good Will” has nothing to do with how much people like your company; Good Will is defined as the difference between your company’s market value (what someone is willing to pay for it) and the value of your net assets (assets minus liabilities). Typically, companies have at least some Good Will, so in most cases you receive a higher valuation by using one of the other methods described below.
Industry specific based valuations
Some sectors often have conventional models such as percentage of sales; a multiple of revenue or a price per customer or agreement, but often they are all surrogates for an underlying valuation model which is based on ongoing profitability at the current level. Often this type of valuation is used as it is easy to understand and is not as not sophisticated as the valuation technique below which is based on future earnings.
Discounted Cash Flow or EBIT Multiple
In this method, the buyer is estimating what your future stream of cash flow is worth to them today. They start by trying to figure out how much profit you expect to make in the next few years. The more stable and predictable your cash flows, the more years of future cash they will consider.
Once the buyer has an estimate of how much profit you’re likely to make in the foreseeable future, and what your business will be worth when they want to sell it in the future, the buyer will apply a “discount rate” that takes into consideration the time value of money. The discount rate is determined by the acquirer’s cost of capital and how risky they perceive your business to be.
Rather than getting hung up on the maths behind the discounted cash flow valuation technique, it’s better to understand the drivers of your value when you use this method. They are:-
1. How much profit your business is expected to make in the future; and
2. How reliable those estimates are.
So in summary, these multiples are only surrogates for the level and risks of future profits. Therefore increase the profits and reduce the risks. This increases the multiple that the buyer will pay.
Often the valuation of a private company is a highly judgemental process. The subjective part is that every buyer’s circumstances are different, and therefore two buyers could see the same set of company financials and offer vastly different amounts to buy the business.
Should you have any questions in regards to the above, please don’t hesitate to contact an Intralink adviser.