Chris Staines | Director | Corporate Finance | BDO Cape Town | mail me |
There are numerous ways to value a business, but which one can help me arrive at a useful approximation – specifically if I want to sell my business?
Methods include:
- An asset-based valuation plus an assessment of goodwill
- A discounted cash-flow valuation
- An industry specific ‘norm’
- A multiple of earnings valuation
I have been selling private businesses for over 25 years in the UK, Australia and South Africa, and have found that nine times out of ten it is the last one, the Multiple of Earnings method, that can be used to give the quickest and most useful approximation for the vast majority of businesses.
Clearly, if your business is loss-making or its value relates almost entirely, say, to the ownership of a property or other asset rather than from profits derived from trading, then other methods could be more appropriate.
But if your business displays broadly the following characteristics, and you are prepared to sell a majority stake for an up-front payment (i.e. without deferred consideration), then it should be possible to provide a rough indication of value using the Multiple of Earnings valuation methodology:
- Your business has been trading profitably for three or more years
- Your business has been making ‘normalised’ profits broadly within the ‘standard range’ for your industry.
- Your business is forecast to carry on trading in broadly the same manner, and with the same level of profitability.
So how does this work?
First of all, although simple – this rule of thumb is not quite as straight forward as people think. As the valuation name implies, there are two elements to the methodology, and both must be assessed correctly to give the most accurate ball-park figure. But this shouldn’t take too long.
The Earnings
The easiest way to determine the earnings to which the multiple must be applied is simply to take the most recent after-tax profits from your audited accounts. But if you do this alone, you could be leaving serious value on the table – and you may be able to make a case for a far better number.
Factors to consider are:
- Where you are in your financial year. If you have a February year end, and it is already November – then you could easily make a case for more weight to be given to the current financial year (especially if you can support your forecasts with some hard evidence) than the previous one.
- Whether your profits have been ‘normalised’. There are often a number of expenses that, in the ordinary course of business, would not appear in your books. Perhaps you pay yourself way above market-rates. Perhaps there was a once-off expense that won’t be repeated. Perhaps your spouse manages the switch-board but is paid as much as a director.
- Whether your profits have been…
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Read the full article by Chris Staines, Director Corporate Finance, BDO Cape Town, as well as a host of other topical management articles written by professionals, consultants and academics in the August/September 2019 edition of BusinessBrief.
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