There are many considerations when determining the value of your business. In fact there are many common methods which will provide you with a starting point and a rough idea as to what your business may be worth. What’s more, knowing and understanding how to value a business can help you understand where the value lies and how to maximise the value of your business. The following key business value principles set the foundation for what a business will be worth when it is sold.
Value is determined at a specific point in time
Value can be very volatile as exhibited by shifts in share markets. Trading for $1.52 today, the shares may only trade at $1.36 tomorrow. The key to remember is value can be volatile and is dependent upon factors that can and sometimes do change relatively quickly. For instance, what is the impact on the value of a business that loses a customer without warning that accounted for 25% of sales, with no prospect for replacement in sight? Obviously it is very significant. Value tip: Timing is critical. When you transact in an industry or financial cycle, this can have a significant impact on value.
Value is usually a function of prospective, discretionary cash flow
The value of a business is generally a function of what it may earn – not what it did earn in the past. However, historic results, suitably adjusted for non-recurring items, can sometimes be indicative of a trend line for the future. Value tip: Vendor’s earnings projections, which often show increases, need to be backed by supportable assumptions.
Market rates of return provide benchmark indicators of value
The best evidence of value lies in the markets. What are businesses of the same size, in the same industry, with similar growth and risk profiles, selling for today? What are the trading multiples of shares of public companies in the same industry? Are such multiples even relevant? What adjustments need to be made to market data for it to be comparable to the subject company? The influence that one or two key management personal can have in a medium sized private company also makes the determination of comparability, in particular with a public company, a difficult exercise. Value tip: All other things being equal, public companies generally trade at higher multiples of cash flow and/or earnings than private companies, due to their size, growth prospects and diversification of risk.
For goodwill to have value it must be transferable to the new owner
People make money. Capital and equipment are just inputs into the equation. It is people who determine whether the business makes a little or a lot from the assets employed in the business. Value tip: The unidentifiable intangible value, otherwise known as “blue sky” or goodwill value needs to attach to the business and not to the selling shareholder. Put alternatively, to the extent practical, in order to commercialise goodwill the business should become less dependent on its principal shareholder/manager, before it is sold.
The greater liquidity of the business interest, the greater the value
In this context consider liquidity in terms of the number of potential buyers for the business interest. Simply put, the more prospective buyers are around during the sale process, the greater the likelihood of a achieving a higher selling price for the business. Value tip: A controlled buy/sell process is the key to a successful outcome. It is easy to get derailed by a very high indicative, exclusive bid, received early in the sale process, that fails to materialise at anything like the same levels after due diligence.
A controlling interest may have greater value than a minority interest
Control is a valuable asset, often bitterly fought for in the public markets. In the public company environment the value of control is evidenced in control premiums paid on takeovers and on the trading premium of voting over non-voting shares. In private companies, absent a shareholders’ agreement, the lack of control is often expressed by minority discounts from pro-rata value. Value tip: a small shareholding in a private company can be extremely illiquid, subject to abuse by the controlling shareholder and in the absence of a shareholders’ agreement, in some cases worth very little.