Businesses, like cars, horses and anything else you care to mention, are worth what someone is prepared to pay. And the bad news is that all businesses are unique, so any overly simplistic valuation method is going to be, at the very least, unreliable. The good news is that with uncertainty lies opportunity.
Having bought and sold businesses myself, and interviewed a range of commercial lawyers, accountants and business brokers on the subject, what follows represents four of the key ‘get rights’ when considering how to maximise the value of your business:
Don’t just accept a simplistic ‘multiples’ approach
By far the most common method of valuing a privately owned business
(plcs are a little different) is to apply the ‘multiples’ approach. At
its simplest level this involves annual post-tax profits being
multiplied by a set figure to arrive at a final price. Many
accountants, lawyers and business brokers will use this as their
primary valuation tool.
An example:
Post tax profits: £100,000
Multiplier: Six times
Business value: 6 x £100,000 = £600,000
Unless your business is unusual in some way (for example, having very significant property or other capital assets), most professional advisers will suggest the multiples approach is used. There is a flaw, however. Where did the number six come from? I made it up: which is exactly what professional advisers may do when you ask them to help value your business. And if I had picked the number seven instead, you might consider yourself to be £100,000 richer.
This isn’t the only issue. You might believe that post-tax profits are reasonably fixed but this is often not the case. There are many things that can be done to (legally and sensibly) increase the net profit figure. Getting either multiplier or profit figures wrong can seriously affect your wealth.
So, while the multiples method might make a reasonable rule of thumb, what other factors ought to be considered?
Be intangible
For much of the 20th century, tangible assets were the key determinant
of a business’ value. Own lots of factories, warehouses and stock, and
you were rich. But in the modern era things aren’t quite so
straightforward. The real value in many businesses lies in intangible
factors – data, design, creativity, innovative solutions, customer
relationships – all of these can combine to make an enormous impact on
the value of your business.
If you need convincing of this fact check out the market capitalisation of Google, then compare the figure with either its assets or current net profit levels; you may be surprised by the results. The most valuable modern day assets are found in our heads, not our factories. You don’t have to be a leading edge technology-driven business to maximise value.
There are many ways to manipulate and profit from the know-how in your business, however modest its size, and whatever your industry sector. The problem is no one really knows how to value intangibles and buyers in particular can be reluctant to pay top dollar. The solution lies in making your business ‘investment ready’.
Be investment ready
Being investment ready involves planning, discipline and clear
thinking. Your business will be attractive to others if answers to the
following questions are both credible and demonstrable without a great
deal of analysis or number crunching:
1. How does the business generate profits?
2. Why will it continue to do so?
3. How can profits be increased?
Answers to these questions will be found in the operating model of your business, but for many companies the model in unclear. Lack of clarity must be avoided if you are to create a compelling investment story for prospective buyers.
Create a great investment story
Many owner/managers fail to create a compelling investment story when
selling their business, perhaps relying on their chartered accountant
to crunch a few numbers and help draft a modest prospectus. Doing the
basics is not enough: your investment story must be convincing, very
easy to understand and call prospective buyers into action. Its role is
to demonstrate investment readiness.
Valuing a business means understanding the drivers that underpin an external assessment of a company’s worth. Relying on overly simplistic multiples may not be enough. At the very least you need to uncover and analyse the factors that drive multiples upwards; why be a seven when an eight or 12 would be much more rewarding?
Andrew Heslop is the author of How to value and sell your business, published by Kogan Page. For more information see www.kogan-page.co.uk