Do you know what your business is worth?
Do you know how much your business is worth? Whether you’re thinking of selling or just plain curious, it’s interesting to note that owners are prone to overestimating the market value of their business.
This tendency to overvalue their business can lead owners to have false expectations regarding what potential buyers are willing to pay for it. And consequently, be ill-prepared when they do choose to exit. Being aware of the factors that determine how much your business is worth can help you be better prepared when you do commit to a handover and so avoid disappointment.
Some of these factors are self-evident; others more elusive. Some you can control; others you may just have to accept. Either way, getting to grips with these influencing factors will help you to be realistic about the selling price your business could fetch currently and empower you to increase this price tag in the coming months or years.
So, let’s get right down to the ten most critical considerations impacting the market value of your business.
Why you’re selling
The reasons you’re selling your business can have a significant influence on your bargaining power. Selling up due to illness or being forced to put your business on the market for another reason automatically puts the buyer in a stronger position which is obviously detrimental for you. The more time you have to negotiate a deal, the stronger your bargaining position.
The size of your business
It’s a case of bigger is perceived as better. And less risky. Unfortunately, size does count. A larger company is viewed as more established and stable with the potential to generate higher revenues and weather market volatility. All plus points in the eyes of prospective buyers.
How many years your business has been operating
The longevity of your business is another primary consideration. But it is about more than just how many years you have been running; how successfully you’ve been operating – your track record – is as essential.
Being able to demonstrate a steady cash flow, an established and loyal customer base, consistent performance delivery, and stable recurring revenues ticks a lot of boxes for potential buyers.
Businesses which have only been trading for a couple of years present as far riskier even if their performance delivery has been impressive to date. It may be too soon to tell if they have what it takes to endure or if they are merely riding a short-lived market trend.
The nature of your business assets
The type of business you own generally determines the nature of its assets. For example, an office-based business will likely have far fewer tangible assets compared with a manufacturing business.
Such physical assets as buildings, warehouses, machinery, hardware, and stock can make a business easier to value than one where intellectual property is the primary asset. A simple asset valuation can be attained by adding up the tangible assets and then subtracting the liabilities.
The reality, however, is that the nature of a business’s assets is more complex than stated above. The overall value of an enterprise also depends on factors like customer loyalty, proprietary innovations, brand strength, and so on.
Your EBIT rating
Any prospective buyer worth his or her salt will want to know about your EBIT – earnings before interest and tax – rating. It essentially puts a figure on your profit. The EBIT rating outlines the difference between your operating expenses, bar interest and income tax expenses, and your operating revenues.
And a multiple of EBIT is a typical method for calculating the value of your business. For example, take a three times multiple for a business with an EBIT of $400,000; this works out to a value of $1.2 million, while a five times multiple for an EBIT of $500,000 delivers a valuation of $2.5 million.
What is viewed as a ‘normal’ EBIT multiple will vary between industries and be influenced by some of the factors discussed in this article as well as market sentiment. In a bull market with lots of buyers, valuations will automatically be greater, and a business could command up to 10 times its EBIT multiple. However, that same business may only command three times its EBIT multiple in less bullish conditions. Clearly, timing is crucial to the outcome of your valuation.
What lies ahead
While past performance and cash flows may indicate financial stability, how well your business is expected to perform in the future, and its projected earnings is what will have the buyers lining up.
Also crucial is how well your business fares with regards to attracting new clients and creating expanding an existing revenue stream. In short, does your business have the potential for continued growth? And how stable is that growth? Also, is the growth genuine? Are you effectively retaining your new customers and maintaining the resulting increase in cash flow? Or do you have a revolving door situation where former clients are dropping out as quickly as new ones are recruited?
The nature of your industry
Which industry sector your business is in influences its value for two main reasons.
Whether your industry is experiencing a boom or bust period plays a role in determining your business’s value. It stands to reason that selling in a boom time is better than selling during a depressed period. Say you’re a farmer and the agricultural sector is under pressure due to a prolonged drought; it’s clear the timing is not in your favour and that your leverage as a seller is undermined.
For a more in-depth understanding of your industry status quo, it would be helpful to consult an expert who has access to data on businesses that have recently been sold to establish the norm for valuations in your sector.
Secondly, the industry sector in which you operate may dictate rules specific to the sale of related businesses, rules that may not apply to other sectors. For instance, if you run a real estate agency, the number of outlets you have will determine your business’s value. Or if you run a mobile phone provider, it will be the number of customers which plays a role in the price you can command for your company.
Deal or no deal
As the saying goes ‘the devil is in the details’ and it is no different for the deal you strike when selling your business. In this case, your willingness to be flexible and meet the needs of the buyer may position you to negotiate a higher price.
There are various ways in which to structure a deal, and each carries its own debt service and tax payable conditions. An all-cash sale, for example, will usually mean a trade-off in terms of accepting a lower value as opposed to a deal which is backed by financing.
Some general guidelines governing deal-making are as follows:
- Businesses sold without seller financing usually command 10 – 15% less.
- Offloading your stock means a once-off capital gains tax for you. The buyer, however, may prefer an asset sale to reduce the income tax due.
- As consulting expenses are deemed tax deductible, buyers may place more value on a business with a greater consulting allocation. On the other hand, you, as the seller, may prefer to limit the allocation to consulting and so limit the amount of regular income tax that will you be charged on this count.
The cost of accessing capital
High interest rates mean less investor borrowing. It’s a given market trend and will naturally have an impact on the value of your business. When inflation is on the up, there will be fewer potential buyers, and they will be primed to drive a harder bargain due to the greater degree of risk involved. When inflation drops, and financing is more readily available and carries a lower interest rate, the market automatically switches to favour the seller.
Other intangibles in play
There are many subjective factors that must be weighed when valuing a business; factors that may be tricky to quantify and which may depend on perception rather than cold, hard fact. These include:
- How important is the owner’s role in determining the success of the business?
- Is the business favourably located?
- Does the business depend too heavily on a small customer base?
- Are the business’s customer and supplier relationships strong enough to endure a sale?
- The same applies to the staff and management; are they likely to remain post-sale?
- Does the business include valued intellectual property – like trademarks and patents?
- Are the procedures, processes, and systems well defined and documented?
- What is the state of the business’s reputation?
- Is it marketable?
- And favourably positioned when compared with its competitors?
Now that you have a more comprehensive idea of the factors that impact the market value of your business, you can take steps to protect against false expectations and ensure you’re not forced to sell for less than you would like.
SMART Business Solutions can assist you in preparing all your paperwork – including cash flow statements, historical and projected profit, and loss statements, and so on – so when you do choose to exit, it will be on the most favourable terms possible. So, if you’d like to get your business into shape for when the right opportunity presents itself, contact SMART Business Solutions today.
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