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Valuing your Business for Sale

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17 / Mar / 2008

When it comes time to sell your business, it’s helpful to understand what the buyer is looking for in terms of predictability of revenues and profits. De-risking the business and building its ‘sustainability’ all helps to boost the selling price.

IT HAS BEEN ESTIMATED that over the next 10 years more than 400,000 privately owned businesses with a combined value of $1.6 trillion will be on the market, so there is no real surprise that the market is becoming increasingly competitive. Yet few business owners would accurately know what their business is worth or even how to increase the worth of their business.

Having a clear understanding of the value of your business should play a critical role in the creation of an exit strategy and should be considered long before the decision is made to sell. A valuation can be viewed as the first step in enhancing the value of a business. A professional valuation may assist the owner in identifying the company’s key value drivers, which can then be maximised and strengthened.

Every industry and indeed business has its own set of value drivers. What makes a business attractive to purchasers include:

  • Profitability and financial stability – Sustained profitability, sound margins and a strong balance sheet demonstrate an ability to generate positive cash flow and provide a strong prospect for future growth
  • Market share – A strong position in the market reflected through, among other things, recognisable brands and a solid customer portfolio
  • Barriers to entry – A sound protection strategy to protect market position; particularly the ability to operate at a lower cost relative to competitors, strong industry expertise and protected intellectual property
  • Management – An experienced, future-focused management team; and
  • Industry sector – The dynamics and maturity level of the industry sector may affect the expansion ability of companies in that particular industry.

By focusing on the value drivers of the business the owner is better able to view the business from the perspective of an investor, which is crucial in preparing the business for sale. The value placed on the business must be based on objective reasoning rather than subjective feelings. Although the business may be the product of years of laborious work it is only worth what a purchaser is willing to pay. Furthermore, a valuation may reveal unforeseen weaknesses, which should be addressed when preparing the business for sale.

Private company valuations

When valuing a publicly listed company, much of the necessary information is readily available in the public domain. A private company, however, cannot be valued strictly on the basis of comparable public company share prices. Valuing a private company can be far more complex due to a number of factors including:

  • The information available about a private company (both in terms of history and depth) which is generally far more limited than that of a publicly listed company. This is in part due to the fact that private companies are not governed by such stringent accounting and reporting standards as their publicly traded counterparts
  • The absence of a ready market for private companies’ equity creates a lack of liquidity for which shareholders need to be compensated. This must be factored into the valuation; and
  • The lack of separation between the owner and management tends to result in a mixture of personal expenses with business expenses as well as a failure to distinguish between management salary and dividends.

Valuation methodologies

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Valuation of assets and goodwill

In the use of the estimated future maintainable earnings method there is often a discernable gap between the intrinsic value of the business and the value of the net tangible assets. This difference is the value of the goodwill and intangible assets.
The recent valuation of the brand name Kodak at $4.4 billion is testimony to the importance of intangible assets to a business’s value. While most private businesses could only dream of achieving intangible asset valuations in the same sphere as Kodak, it is an issue that must not be neglected. For many businesses goodwill and intangible assets are their biggest value drivers.
The valuation of intangible assets has its own unique concerns, which must be addressed in order for the owner to achieve the best possible outcome from the sale. It can be particularly challenging for owners wishing to sell to competitors or where the purchaser may require external funding from a bank or building society.
Financial institutions are generally wary about lending large sums of capital to purchase goodwill or intangible assets. It must be clearly demonstrable that the business’s goodwill and intangible assets are transferable to the purchaser. Key issues in the valuation of intangible assets include:

  • The predicted useful life of the intangible asset
  • Whether the intangible asset is legally protected eg through a patent, trademark etc
  • Comparisons with similar intangible assets in the market
  • The cost involved if the asset were to be recreated in contrast to the cost of the initial creation
  • The level of engagement of the present owner required to maintain the current levels of goodwill; and
  • The predicted future earnings that could be attributed to the intangible assets.

The appointment of an experienced advisor will ensure that the goodwill and intangible assets of your business are recognised and valued appropriately.
Whether your business’s key assets are tangible or intangible, a timely and comprehensive valuation can enhance your understanding of the business’s value drivers and assist in preparing the business for sale.

The process may also assist you in determining the target market for the business, the timing of the exit and the necessary steps needed to best present the business for sale. It is vital that the owner analyse the findings and use the valuation to maximise strengths and opportunities and address exposed risks prior to putting the business on the market.

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