How much is your business worth?
If you are thinking of selling up, what could you get for
your business?
By Paul Brindley, Business Adviser
Tel: 01902 674626
paul_brindley@talk21.com
© Copyright 2003
General Principals
The largest influence on the price you will get for your business
is the Law of Supply & Demand. If, when you sell, there are
plenty of buyers with ready cash and few sellers, you will get
a good price. If the converse is true, you will either not get
a good price or, even worse, you may find you cannot sell up.
Generally, people do not buy a business for what it is; they
will buy for what the business does for them. Namely earn them
cash to repay their investment, provide them with a living,
and build for the future. With cash (not profits) uppermost
in their mind on the first two of these, the price is often
based on something called 'EBITDA'. EBITDA (Earnings Before
Interest, Taxes, Depreciation and Amortisation) is an accountancy
term that represents the sustainable cash profits of the business
assuming nil borrowing costs.
To value the business, a multiple is applied to EBITDA. The
Law of Supply & Demand essentially dictates the multiple for
a particular business sector, or any part of it, or any particular
firm. There is no universally agreed multiple for a particular
sector, or firm, and multiples vary widely between and within
particular sectors depending on a number of factors, but principally
the certainty and size of the future cash flows of the business.
The multiple applied to your business will depend on a combination
of factors, we go into some of these factors in detail below.
Pricing a business is thus more of an art than a precise science.
It is not merely a calculation based on two predetermined numbers,
and valuers, purchasers and vendors often arrive at differing
figures. At the end of the day it is you who has to be satisfied
that you have got the best deal under the circumstances.
To get the best price, the main issue you should concentrate
on is timing. When the business is ripe for sale, it is often
not the right time for you personally or there are too few purchasers
with ready cash. All other permutations apply, except the one
where all the circumstances fit together neatly. Consequently
selling your business generally involves some form of compromise.
This makes the decision more difficult for you, especially if
you are emotionally tied to the business. There is always a
lot going on in the business when you sell, negotiations are
intense, and feelings high: selling is a stressful time for
you. So it is important that you plan in advance how you are
going to sell the business. Only by doing so will you maximise
the price you will get. When planning, you should bear in mind
the following:
Size
Forget the old maxim, size is important. Large firms attract
bigger multiples and more interest than smaller firms because
they are perceived as being less risky. Larger firms are less
likely to fail and are less reliant on the owner's involvement.
Your firm, however large it grows in its niche or how profitable
it becomes, may be too small to attract the right purchaser,
namely the one with cash. Thus ignore the price achieved for
one of your larger, more inefficient, competitors: you may never
achieve a similar multiple however good your business is.
Growth
Growth prospects are one of the more major factors affecting
the multiple. Buyers will pay more for businesses with higher
growth rates as they repay their initial investment quicker
than those with low or no growth. Consider selling up before
turnover or profits have levelled out. This may go against the
grain where you have put in place the basis for such growth,
but increasing the multiple, as opposed to increasing the EBITDA,
will have a bigger impact on the price you achieve.
Profitability
High gross margins and good levels of cash generation from
profits give buyers more flexibility going forward and reduce
the risk of the investment proving bad. Buyers will pay more
for businesses that consistently report better than industry
average figures.
However, the fact that you operate an extremely tight ship may
put a buyer off paying too high a price. Buyers will look for
easy wins/cost savings, so if a buyer identifies areas where
he can make large efficiency savings or growth that could make
your company more valuable to him. It is often worthwhile specifically
targeting potential purchasers able to achieve such synergies.
Sector
Some sectors attract better multiples than others. There are
a number of reasons for this: fashion (such as the dot-coms,
energy businesses etc); estimates as to future growth prospects;
robustness at times of boom and bust etc. In general, the more
certain the future cash flows of a sector, or company, the higher
the multiple.
However, some niches within a sector can command a premium from
time to time, depending on the then demand for the particular
product/service. Building a 'sustainable competitive advantage'
and 'Unique Selling Point(s)' in a small niche can produce a
handsome price at a time of boom in that sector generally and
a better than average price when times are bad.
Business Mix
Diversification, although often reducing operating risk, does
not always add to value: it can reduce the value of the overall
business. Buyers may only be willing to take on that part of
your business that fits in well with theirs; they could either
discount the overall price, leave you with the part they do
not want or, in the worst case, you could find your business
un-saleable. It may be safer to stay in a particular part of
the sector, especially for smaller businesses, as it can be
difficult to find a buyer who will appreciate diversity.
Customer Base
The quality of your customer base is one of the main factors
influencing the multiple used. Customer bases made up of blue
chip clients in growing industries attract higher multiples,
particularly if there are opportunities for the buyer to sell
additional services in to them. If specific customers, or customers
in a particular industry, make up a large part of your business,
it will affect your pricing, because buyers will see you as
having too many eggs in one basket.
Other Factors
Another important component is the strength of the balance
sheet. Once buyers have bought a business, they want to focus
on growing it and integrating it into their own organisation,
rather than deal with historic balance sheet problems.
Buyers will assess the former owner's management of working
capital. Businesses with a history of good cash, debtor, and
creditor management attract higher multiples than those with
a poor track record.
Other balance sheet factors that can influence a firm's value
such as the amount of bank / factor debt, and any impending
litigation.
The Deal
It is important to many buyers to retain the owner, at least
for a period of time, to help introduce them to customers and
make sure staff are comfortable with the new regime.
Often a buyer will agree to pay an incentive (this is termed
an 'earnout') to the owner to encourage him to stay and to seek
to avoid bearing the entire risk of the acquisition. Buyers
often look to pay the former owner a share of profits earned
over a two or three year period.
Earnouts can constitute a major part of the purchase price.
The smaller the company, the more uncertainties there are that
could affect how the business might perform, and thus the more
likely it is that the buyer will seek an earnout. With planning
an exit taking up to two/three years, and the earnout a similar
period, it could be five years before you can book your sun
lounger fulltime.
Earnouts is one area where your advisers really earn their money.
Earnouts create conflicting interests between the current and
former owners of the business; there is a risk that the buyer
will look to reduce or defer profits in order to minimise the
earnout paid. The former owner will look to maximise profits
and hasten their recognition. With the former owner having little
or no influence post sale over strategy, accounting policies,
expenditure etc, there is a very real risk that he could receive
less than originally envisaged for the business. It is important
that your advisers protect your position wherever possible.
There is a balancing act to be struck, you will have to decide
how much money you are willing to wait for and form your own
view of the risks involved based on the likely future profitability
of the business and your assessment of the purchaser, as against
accepting a lesser, but more certain, sum now.
Today's Market
At the end of the day, any business is only worth what you
can get for it at the time you sell it. A mathematical calculation
of value is a mere indication of potential worth, a discussion
tool to be used during the negotiation process. Confidence levels
set the level of demand for your business, and in turn how much
purchasers may be willing to pay for it. Whilst any downturn
will ultimately effect multiples, to get maximum value and increase
the certainty of a sale, it is more important than ever that
owners considering selling prepare and position their business
ready for sale early, and that during the sale process is carried
out in such a way as to target purchasers with the right fit,
hunger and cash to complete a deal.
Further Information
By Paul Brindley, Business Adviser
Tel: 01902 674626
Mobile: 07813 102014
paul_brindley@talk21.com
© Copyright 2003
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