While there are some standard approaches to working out worth, their effectiveness and relevance varies greatly depending on the unique structure and assets (tangible and intangible) of the individual enterprise under scrutiny.
The first hurdle to get over is your own emotional bias. You have most likely poured years of sweat and tears into your business. It may have been in the family for generations. You may even think of it as your ‘baby’. Putting a price tag on something you love is really hard – which is why it’s vital to call in the professionals when it comes to valuation.
Hire your own financial advisor to help you work out what your business is really worth.
Once you have decided to sell, the buyer’s own broker, legal and financial advisors will be guiding them through the steps it takes to discover if your sale price reflects true value. This ‘due diligence’ process is unavoidable, which is why it’s always good to have an idea of the value of your business throughout its life. This will be key to knowing when it might be the right time to sell and getting the best price you can.
Checking what other businesses are selling for in the current market is worthwhile, but more vital is being well aware of your own profit and loss statement,
‘A healthy balance sheet and favourable market conditions are two key indicators that now might be a good time to sell.’ - Andy Cagnetta, CEO at Transworld Business Brokers
When you’ve made that all important decision, the formal valuation process is usually approached from three different angles: asset, income and market. Here, we look at these different methods and the variables that must also be considered:
The Asset Approach
In this case, all the businesses assets are added up and depreciated accordingly. Tangible assets (we’ll get to intangibles later) can include the physical property, furniture and equipment as well as valuable intellectual property like patents, trademarks or incorporation documents.
Of course, this method ignores the value tied up in potential earnings and is usually only used in exclusion for liquidations or non-thriving businesses.
The Income Approach
This approach involves the calculation of the current net value of the business’ income. A projection is made in relation to future cash flows and discounted (based on the age of the business and future earnings instability) to determine their present value.
A variation of this approach is in finding the businesses’ EBITDA (Earnings Before interest, Tax, Depreciation and Amortization) and multiplying this figure by a certain factor.
An SME is often valued at between two and four times its cash flow – worked out as EBITDA plus the current owner’s elective salary and benefits. This offers a rough guide to a company's profitability and its subsequent ability to repay interest or debts.
Considering that up to 80 percent of a business' purchase price is usually financed, potential buyers will want to assess how well the cash flow will support the debt repayment whilst also offering a good ROI (Return On Investment) and a decent salary.
The Market Approach
This is the most subjective approach of the three. It doesn’t try to project cash flow or potential rate of return but instead offers an estimate of a business’ earning potential based on current market demand. Worth is determined by the evaluation of other similar businesses that have already sold and comparing the sales price to metrics such as revenue or earnings.
Of course, most business valuations involve a mixture of all of these approaches with a number of variables thrown in. We spoke to an expert in the art of valuation, Andy Cagnetta, CEO at Transworld Business Brokers on what they might be:
What creates value in a business, beyond assets and liabilities?
‘For me the bottom line is the bottom line. Profits trump everything in valuation. I could care less about assets if they don't drive profits. So it is incredibly important to know the value drivers...like intangibles. It could be location, price, products, vendors, customer mix, name, website, marketing, niche....it could be a combination of them all, like a good recipe. Leave one ingredient out of a good cake and it will fall flat.’
Aside from the standard valuation approaches, what really makes a business valuable to a potential buyer?
'What would you rather own - a landscaping business that makes £500,000 where you have to wake up at 4am, run five crews of blue collar workers with issues like weather, equipment failure, tardiness, labor shortages, etc....or a distribution business that makes £500,000 that is open Monday to Friday, 9-5, has four office workers, low inventory, and a niche clientele.'
‘The easier it is for a new owner to acquire the business and continue the earnings stream, the more valuable the business.’ - Andrew Markou, CEO of BusinessesForSale.com.
What do you make of the many online business valuators that are available today?
'I wouldn't rely on a website to predict what a business would sell for, but then again a £25,000 valuation may not get you close either. I guess that is why they say business valuation is an art not a science. It’s hard to have a computer spit out art...although that day is getting closer to reality.'
It seems that valuing a business does indeed require a creative and subjective eye, whatever scientific approaches have been applied. But the ‘bottom line’ remains the same: the easier it is for a buyer to purchase the business and continue making money, the more valuable the business.
Beauty in business, as in art itself, is in the eye of the beholder.