It’s a well-known concept that, essentially, ‘the business is worth whatever someone is willing to pay for it’, but there are some fundamental principles, both on a financial and non-financial basis, upon which a business valuation is made.
Does the business have a strong balance sheet with plenty of cash? Is there a lot of debt within the company that a buyer may have to take on? Are trade debtors and stock balances well managed and at a level expected for this industry?
These are some of the fundamental questions that potential buyers will consider when valuing your business. It is therefore essential to ensure that your balance sheet undergoes a ‘spring-clean’. Dispose of obsolete stock lines, clear old trade debtors that are not recoverable, and ensure your fixed asset register is up to date and does not contain any scrapped or out of use equipment.
Theoretically, the business is at a minimum, worth its net asset value, however this does not factor in ‘goodwill’. Goodwill refers to the intangible assets that contribute to a business’s success, for example, brand and reputation, strong and loyal customer relationships or a skilled workforce.
From a commercial perspective, we would always expect a buyer to pay a certain amount for goodwill, which is generally based on profitability. Potential buyers will want to see current and historical accounts to scrutinise profit levels and year on year margins, to ensure they are consistent and maintainable, as well as looking if they can be improved upon.
If you are considering selling your business, now is not the time to experiment with new product lines or new sales strategies. To improve your company’s value, you need to maximise your high margin sales and eradicate any loss-making lines.
Buyers will then multiply the average of your past, current and possibly future profit levels by a profit ‘multiple’, in order to calculate the amount they will attribute to the goodwill of the business. The profit multiples applied by a buyer will vary dependent on the level of risk they assign to your company. The lower the perceived risk, the higher the profit multiple. Multiples can range anywhere from 1 – 5. Higher multiples tend to be achieved where the business has a unique advantage in the industry but as a general rule of thumb, you can expect to achieve anything between 1 and 3.
Potential buyers will also consider non-financial aspects of the business, as this will allow them to assess the level of risk they may be taking on, which will also undoubtedly impact the valuation.
Areas that they will consider, include:
- Clear, strong and reliable operating systems
- Stable and capable staff structure
- Strength and breadth of customer relationships
- Quality and range of products/services
- Potential for diversification
- The availability of regular clear management information and KPI’s
Essentially, valuations are fundamentally based on the three aspects of Net Assets, Profitability and Non Financial Principles , and the balance sheet is an instant insight into the lowest value you should expect to achieve for your company. However, goodwill is highly subjective and varies hugely based on what a buyer thinks they can achieve if they were at the helm. Just remember to have a realistic expectation of what your business is worth when you come to sell your business to ensure you don’t undervalue the work you’ve put in, possibly a lifetime’s worth.