I have recently been passed a referral from a contact who had a client that was looking to sell his business.
The business itself was labour intensive for the director and he had found himself working all hours, 7 days a week. Although the company was making a large amount of profit it was not the money that was now motivating the director, he needed more time to spend with his family, particularly at weekends.
The answer in the end, once we had discussed the assignment in detail, was to set up a group of companies and to bring in an outside management team and in turn fresh investment to allow the director to share in the businesses success but no longer be responsible for running the show, he was now able to concentrate on other matters.
However, at one stage during the assignment the director had received an offer for his shares. Bearing in mind the company had only been trading for a relatively short amount of time but had plans for rapid growth, the offer was a considerable sum. Upon receiving this offer the client asked me ‘what is my business worth?’ He was obviously anxious that if he sold the business too cheap, not taking into account the planned growth, he would look back in years to come with some regret.
Placing a value on a business with planned growth is notoriously difficult and a number of factors would need to be considered.
Why would you value a business?
You can value a business not only for buying and selling as you may want a current value to raise equity or even provide a measurement for management performance that can be assessed periodically.
An example of valuation techniques
Asset value
Often used for property businesses or on some occasions in manufacturing. You would start with the net book value taken from the accounts and then adjust the larger items to take into account the current market rates.
Multiple of profits
Average monthly/annual profits are adjusted to not include one-off factors like exceptional costs or a one-off purchase. This will give you a good indication of the immediate future profits. You then add on any additional costs or gains that the company may make after being sold or invested in and this final profit figure is generally called 'normalised' profits.
The general multiplier for this figure is anything between 3 and 5 times. Smaller businesses would generally be at the lower end of this scale whilst most larger companies with a strong reputation can be towards much higher.
This method is generally used by businesses with a track record of profitability.
Entry cost
What would the cost be of starting a similar business from scratch? You have a ready made business that an investor can buy into and enjoy now.
Discounted cashflow
Probably the most technical way of valuing a business as it depends on assumptions about the long term prospects and is often used in mature very stable businesses. The valuation is based upon the sum of the dividends forecasted for east of the next X amount of years (usually at least 15) plus a residual value at the end of the period.
Other items that might affect the price of a business is the ongoing management of the business. If it relies on the current owner/managers who are planning to leave following the sale then the business may be worth less, for example a marketing agency or businesses in sales with a value attributed to client relationships. Also, if the business has intangible issues, for example a distribution licence, that is expected to be success then the value will increase accordingly.
Ultimately in some circumstances the price of a business will come down to the price that the buyer is prepared to pay. In these circumstances the valuation methods above are merely a basis for you to start the discussions.
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