Business valuation consists of a number of both quantitative and qualitative factors. However, ultimately it is a subjective decision. You can put any price you want on a business, but will it sell?
In most situations, particularly when a company is for sale, valuations placed on businesses by the vendor or their advisors tend to be inflated. This causes confusion as the same business can be priced at two ends of an extravagant range. The outcome can be swift if the gap is too wide: the buyer moves on.
So, how can you trust the valuation presented to you?
The starting point for business valuation is comprised of scrutiny of the assets and goodwill of the company. Valuing assets is relatively simple as they are often paid for based on the net assets within the business.
For a debt free, cash free sale, the vendor retains them on exit. Trade debtors can be bought at value, and catered for in the deal structure, with any bad debt deducted.
The complexity comes from valuing the goodwill. Goodwill is usually based on a multiple of the company’s adjusted EBITDA. Adjustments can both increase and decrease the EBITDA and normally would be up for discussion between the two parties.
An example of where deductions are applied is when a key Director is underpaying themselves. For example, if the company owner is also the Managing Director and receiving a salary of £30,000, this seems low. If the market rate for a replacement MD is £100,000, then there would need to be a deduction of £70,000 from the EBITDA.
Conversely, if the income package had an additional £200,000 in pension payments and other benefits in kind, it results in an add-back of £130,000.
As you can see, there are many considerations such as these when selling a business.
The multiple of the adjusted EBITDA is a matter of opinion, however there are several factors that influence this.
The first consideration is the EBITDA figure itself, the higher it is, the better the multiple. It is worth noting too that a resilient sector or one with growth potential will command a higher multiple. A good management team has the same effect.
Valuations usually fall into the ranges below (see the table), though careful consideration of the qualitative factors stated earlier. It is possible, in exceptional circumstances, for the value to be significantly outside of these multiples. For example, contracted earnings, year on year growth, significantly high profitability, and intellectual property and/or patents could be reasons why the business should be worth more.
|Less than £250k||2-4|
|£250k - £500k||3-5|
|£500k - £1m||4-6|
|£1m - £5m||5-10|
It is also worth noting that declining businesses, marginal profitability, owner-dependence, and low barriers to entry could be reasons for a lower multiple.
Finally, there are some sectors, particularly those with retained long-term client bases, where the multiple is applied to the Turnover and not the EBITDA. In these instances, though, the multiple is generally much lower.
Otherwise, almost all buyers will value within these ballpark figures. If you believe your business is worth more then you will need to consider the compelling reasons for this to be the case.
The most important factor in gaining a realistic business valuation is that it should be independent. You do not want external factors to bias calculation.
It is a known fact that most business brokers overvalue businesses to entice owners to choose them to take them to market, but it is also fair to say that acquirers can tend to undervalue, certainly with the first offer, and can focus on problems to reduce the offer price or terms.
If you receive a valuation, make sure you understand in detail how they arrived at that figure. Don’t just take it as read:
If they cannot satisfy these questions or have not received the necessary information to make these projections, they cannot possibly come up with a sensible asking price for your company.
If you are just considering a valuation, we recommend that the company undertaking the valuation should be actively involved in Mergers and Acquisitions. M&A is constantly adapting to changing market conditions, no more so than in 2020, and sentiment also impacts value.
Therefore, it is essential that the valuation is based on recent evidence, not older methods or a ‘finger in the air’. You can put any price on a business, but will it sell?
Understanding the value of a business is critical for both buyers and sellers. We can help you reach an independent market valuation for your business or the business you are intending to buy. Call us on 0333 050 8225 to discuss your valuation needs.
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