Selling a Company
The decision to sell your business is likely to be one of the most important you will ever make, but having made it, it is essential to go about the process in the correct manner and appoint a professional who is very experienced in ensuring you obtain maximum value whilst maintaining utmost confidentiality during the process. After all, if your customers, employees or suppliers find out you are thinking of selling, you may find that the value of your business deteriorates very rapidly.
All owners are keen to know the valuation of their business but this is not a simple question and many methodologies may be utilised in attempting to provide an answer.
The choice of valuation methodology used may be affected by a number of factors, such as:
The prevailing circumstances
An ongoing business can be valued in many different ways (see below) whereas a “distress sale” would drive down the price.
The importance of the assets in generating the revenue is a factor eg, an investment property business will have significant tangible assets whereas a service organisation may have little or no assets on its balance sheet.
The age of the business and where it presently stands in its “life cycle”
Many businesses make a loss in the early years, during which time they may appear to have little or no value from a balance sheet (or profit & loss account) perspective, but are still highly valuable in terms of potential earnings.
Any valuation attached to a business will have been made based on a set of external and internal assumptions (eg, current economic conditions such as interest rates, sales forecasts, etc.) which are inherent in arriving at that valuation. Such assumptions may change very quickly and can therefore significantly impact the valuation outcome.
Below are some of the common valuation methodologies in use today:
1. Asset-Based Valaution
Appropriate for asset-rich businesses such as property investment or heavy manufacturing organisations. The principle is to review the balance sheet (plus any hidden assets) and then restate their value to reflect current economic reality. Properties would be revalued to current valuation levels and book debts may need to be written down to reflect potentially irrecoverable amounts. This relatively simple approach would need to be adapted to take account of future earnings potential.
2. Market Entry Cost
This method, not often seen in practice, values a business based on the cost to a new entrant in that sector creating a business similar to the one being valued.
3. Discounted Cashflow
Often used for cash positive, stable organisations. The valuation depends on the level of cash that the business is assumed to generate over a future period of time which is then discounted utilising an appropriate discount factor. The discount rate depends on a combination of the perceived risk and interest rates (or cost of capital).
4. Price-Earnings Ratios (P/E)
This is one of the more common valuation methods especially if the organisation has an established profitable history – a loss-making business would not be valued by this method unless a turn-around in financial performance was envisaged. The P/E Ratio represents the value of a business divided by its post-tax profits. Therefore, if a company has a stable profit level of, say £500,000 and the P/E within the relevant industry sector is 12, the business could be valued at £6,000,000 (i.e. £500,000 x 12). It is important here to be able to determine the correct PE level to utilise. This would be done, for example, by reviewing other transactions which have recently taken place within the same sector or reviewing the prevailing P/E for this sector for quoted companies and applying an appropriate discount (as unquoted companies are, of course, less attractive) .
5. Rule Of Thumb
A simple formula which has been statistically derived from the sale of many businesses of a similar type, eg, a review of the sale of accountancy practices, may show that they are typically sold for 1.5 times gross recurring fee income. This formula may then may become the rule of thumb for accountancy practices. Many ‘experts’ avoid using this approach but it does have its place as a quick starting point for a valuation. However care should be taken, as thumbs come in many shapes and sizes!
- There is no definitive way to determine the value of your business and the valuation process is as much an art as a science
- Valuation methods normally place more emphasis on an organisation’s perceived future ability to generate profits and/or cash rather than the net assets in its balance sheet.
- The real value is the value to a buyer who is ready, willing, and able to buy your business in an ’arms length’ transaction and it is important to note that any such value is unlikely to remain static for any length of time.
- There are a variety of methods used to estimate business value (and a few of these have been touched upon above).
- Differentiate between a broker, who will advertise your business on his website and eshot his database, and a professional adviser, who will add value in the advice he/she provides and the process undertaken with the aim of maximising your interests whilst maintaining confidentiality.
A professional advisor will review your business and may well recommend that you effect some changes (which may significantly improve the potential disposal price) before you initiate the process.
If you are indeed thinking of selling your business it is critical that you talk to an expert at an early stage – a good advisor will truly be worth his weight in gold and at ibd we have a number of advisors who can assist in company valuations.