When it comes to valuing a business, a good number of buyers and sellers can find themselves confused. This is partly because people value businesses in differing ways. These approaches sometimes throw up very different figures even though they are all respected methods! Differing valuations can often be down to the nature of the business that is being valued. For example, some valuation methods will value intellectual property very highly. Others will be more focussed on the value of physical stock. Indeed, since no two businesses are the same, no single valuation method is the ‘right’ one to use.
Having said that, good valuations should come in within expected parameters for both buyers and sellers. When overvalued, a business won’t see any interest from the market – let alone receive realistic offers. On the other hand, an undervalued business will not necessarily receive a warm welcome from business sellers who may prefer to take their company off the market as a result. Low valuations can also put off some serious buyers rather than attract them. As such, getting the valuation right is essential.
We have experience of acting on behalf of both the seller and the buyer to some degree. This gives us a unique opportunity to view on the market as it truly is. Despite this, we notice that the perception persists that a sale advisor will always hike the asking price and try to inflate it to unrealistic levels. In this article, we are going to look at the prices that businesses can demand when on the market. Of particular interest to anyone considering selling their business will be the practice of some sale advisors of placing a valuation on a business that does not warrant it.
EBITDA, otherwise known as earnings before interest, tax, depreciation and amortisation, remains the most commonly used accounting measure that helps to value businesses. Essentially, it is a marker of any firm’s performance. EBITDA offers a convenient way of evaluating a business without the need to also factor in everything from its financial position. Many businesses receive a sales valuation based on a multiple of their EBITDA value.
Firstly, it is worth mentioning that there are businesses which sell for high multiples of their EBITDA valuation. In some cases, this can be five times their EBITDA value, or even more. These valuations are not the norm and are usually for large corporations or operating in a high growth sector. For such businesses, it is highly likely that their EBITDA value tops the £2 million mark.
The only other businesses which gain high multiples of EBITDA are those that create significant buyer competition. For example, they could occupy a unique market position in a sector that is experiencing explosive growth. Alternatively, they might have a one-of-a-kind asset which makes them hard to value conventionally. Currently, such ‘hot’ sectors of the economy include business working in the fast-moving financial technology (FinTech) sector or the much-lauded digital disruption industry. Unless you operate in an industry like these, you will have to expect a lower multiple of your EBITDA value to form your company’s sales price. High multiples don’t really apply to the vast majority of businesses in the UK, unfortunately.
Having a large EBITDA multiple is unlikely, however it is important to understand why sale advisors value businesses so highly. To sell a business successfully, we must take note that a typical sale advisor will also include their fees and charges as a part of the overall pricing structure. Many sale advisors will operate with a fee structure that is largely based on a proportion of the sale price, usually expressed in percentage terms. However, a good number of them will also have a minimum fee in there as well, so the charges that apply are not always directly proportional to the sales price and drive it up.
Inherently, this approach to charging means that advisors will try to keep a business valuation as high as they can. Their client will benefit from this achieved price of course. It will also mean that the advisor is better off from the deal than if they set a lower valuation. In other words, they are sometimes incentivised by their own charging structure to inflate valuations.
The issue that comes about when you want to sell a business with a high valuation is that it can deter potential buyers from taking the sale seriously in the first place. A business valuation that is outlandishly high will reduce the chance of an advisor attracting genuine buyers. It will also reduce their likelihood of selling for their client in the long run. Therefore, sale advisors need to keep a balance between maximising the potential achievable sales price and not going so high that the entire process becomes fruitless.
An issue also sometimes arises in so-called ‘valuation wars’ which can occur between rival advisors. To win a client, some people acting in an advisory capacity will make quotations at the upper end of the valuation scale. Even if they know they can’t deliver on such estimations, it may well ‘win’ clients away from competitors. This isn’t to say that such advisors are incapable or poor at what they do. It is more a reflection that the business sale market is just that – a market. In today’s marketplace, high multiples are simply not realistic except in very specific circumstances.
If you’re selling, then you will need to ask honest questions of your advisor regarding their valuation method and what is a truly realistic sale price. Getting starry-eyed is not helpful. Similarly, if you’re buying, then you ought to push the advisor and the seller regarding valuation, too. Ask pressing questions about add backs and so on. Remember that you can always walk away. After all, it is better to not acquire than to do so on overvalued terms.
Understanding the true value of your business is vital to your business sale process. It is therefore incredibly important that you speak to an independent business who can give you a true valuation. We at Firm Gains offer true market valuations that help you realise the value of your business. Speak to us today on 01962 609 000.
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