The IBA Corporate team has decades of collective experience in valuing businesses and taking those businesses to market. One thing we have never allowed ourselves to do is the old estate agent trick.
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Assessing The Value Of A Business
The IBA Corporate team has decades of collective experience in valuing businesses and taking those businesses to market. One thing we have never allowed ourselves to do is the old estate agent trick. When we see a client, we don’t inflate our initial estimate of a company’s value. It raises sellers’ expectations to an unrealistic degree and it actively deters buyers.
Buyers have an instinctive knowledge of the current and future value of the businesses they purchase and nothing is more likely to put them off making an offer for the company than believing that they’re dealing with a deluded seller and their transfer representative.
So, how do we value your business? What do we look for? What do we try to avoid?
Multiples Are A Crude Measurement Of The Value
When a business is valued by its multiples, this means the profitability over the last three years is multiplied by a number to determine the price a seller asks for his or her business.
For very large companies, the effective multiple might be between 9 times and 20 times the weighted three-year profitability. For smaller companies, the multiple will generally be between 2 times and 6 times.
Traditionally, a weighted figure is used to determine value by multiples – for example, if a business were sold at 6 times multiple, the calculation would be worked out as follows:
- Year 1 – EBITDA x 1
- Year 2 – EBITDA x 2
- Year 3 – EBITDA x 3
Some acquirers are happy with this method although others prefer working with a straight line average over the last three years. If profitability has gone up over the last three years, most buyers would expect to charge a premium on top of the multiple – an approach most acquirers would accept.
However, if profitability had been falling over the last three years, an acquirer would almost certainly expect a discount because:
- Improving the company would mean extra financial investment into your business to stabilise it.
- Your acquirer would almost certainly have to spend more of his or her own personal time on the stabilisation project.
Note – For first-time sellers, the types of business most sought after by investors are the ones that they or their senior management team have to spend the least amount of time attending to.
Multiples are useful in providing a starting point for arriving at the true value of a company but there are problems with relying on it.
Multiples Don't Account For Future Value
When a buyer purchases your business, they are not purchasing it to preserve its current structure, its operational procedures, its revenue, and its profitability in aspic.
Your buyer, in most cases, has some experience in and knowledge of your sector and they will see the acquisition of your business as offering a strategic advantage.
Rightly or wrongly, they will believe that you’re not running your business in the most efficient and profitable way possible despite their admiration of your achievements and their desire to take over your company.
Buyers believe, bluntly, that they can do a better job than you can. They may be able to cross-sell products and services from their existing companies to your business’s customers and vice versa. They may rationalise the running of the business to reduce fixed costs including laying off staff where there is duplication across the larger group. They may be operating at much higher revenue levels than you are and that scale means that they can reduce your unit cost.
A way to approach valuing your business given this knowledge is working out the multiple under your ownership and the multiple under your acquirer’s ownership. You and the acquirer then meet a third or halfway in the middle. You receive a premium for presenting them with a profitable business which is almost oven-ready for the acquirer to take over. Your acquirer buys your company at a discount against its projected future value.
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The Nearly 'Oven-Ready' Business
As mentioned earlier, acquirers like to spend as little of their money as possible on your business after purchase. They normally have many other competing interests as well for their time as do their management teams – this is why businesses which don’t depend on their owners for their survival and prosperity sell for more.
A new buyer will make changes to the way your company is run, its fulfilment procedures, its staffing levels, its IT systems, and more but they will normally step away from doing so for a few months so that the current staff, who are often unsettled by the transfer of ownership, continue to be productive.
For trade buyers, this process of change and integration is much easier to manage. They already have a business or businesses operating in roughly the same sector targeting many of the same customers. The “oven-ready” premium is welcome but it’s never particularly substantial.
The biggest “oven-ready” premium comes on two types of the deal – where we arrange the takeover of your business from an overseas company looking to establish a UK base or where the buyer is diversifying into an area with which they’re largely unfamiliar but in which they can see strategic importance.
The premium in these cases is much more substantial because, for the buyers, it represents an “opportunity cost” risk. Opportunity cost involves comparing the time, money, and effort expended in taking one course of action over another.
For most overseas buyers and for most buyers branching out into broadly unfamiliar territory, they calculate what it would cost in time, money, and effort to build a clone of your business from scratch versus buying it outright.
In most cases, it’s easier and cheaper to purchase a business with knowledgeable employees than it is to try to build a business from nothing with no in-depth knowledge of operating in that sector. These are also the types of deals where an acquirer would request that you stay on during a handover period – you need to be clear in yourself how you feel about that before agreeing to it with an acquirer.
Assets And Debt In Your Valuation
Assets and Debts are an important part of your business and should be included in your valuation. Find out more as to why they should be included in your Business Valuation below:
One question we’re often asked is how assets and cash should be treated for valuation purposes. There are two answers to that question and the answer depends on whether the cash or the assets are essential for the day to day running of your company.
For plant, equipment, machinery, IT, vehicles, and so on which your staff require to fulfill customer orders, you should expect that these assets will not be reflected in the price. Likewise, the cash in your business used to meet its ongoing financial obligations should not be priced in either.
For plant, equipment, machinery, IT, vehicles, cash, and so on which are “surplus” to requirements – in other words, your company could successfully fulfil orders without them – acquirers would expect them to be added to the valuation of your company.
Deal Structures Bridge The Gap
The bigger the gap between the value you place on your company and the valuation an acquirer has in mind, the harder it is to get a deal to complete.
You can command a higher price if you agree to receive payment in tranches over an agreed period of time (also known as deferred consideration). However, as mentioned earlier, there is a risk that you will not receive the agreed sale price in full if the acquirer is incapable of running your old company successfully.
If you’re asked to stay on to help the owner realise the future value of the business, you may ask for an “earn-out” where, in addition to the agreed payments, you receive additional payments based upon the performance of the business. These types of deals are fraught with risk for the seller so you will need to ensure that the sales and purchase agreement contains as tight a definition of how those targets are defined in accounting terms.
To bridge the gap, you may alternatively wish to retain a shareholding in your company and/or request a shareholding in one or more of your acquirer’s other businesses so that you still have “skin in the game”.
Get A Realistic Value From IBA Corporate
Although the business valuation calculators you see online are interesting from an intellectual point of view, the answers they provide bare little to no reflection on the actual worth of your company.
If you are considering taking your company to market, please get in touch with us and one of our advisors will provide you with a realistic valuation and their justifications for assigning that value.
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