What method of valuing a business is best?
There are several methods for valuing a business. The most commonly used method is the Multiple of Earnings, so we will focus on this method in this article.
But what is that, exactly?
The multiple of earning method applies a given multiple, at which companies like yours are sold, to EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) .
Determine the valuation multiple for your business.
We're often asked what is the rule of thumb multiple for valuing a business, and our response is there isn't one. In our experience, each business is unique. They may sell similar products, but their methods will often differ, the quality of their management teams will differ, and their goals, ambitions, and how much the business relies on its owner will also differ.
So, it's very difficult to come up with a "one-size-fits-all" formula to produce a valuation.
However, there are several things that are usually the case:
- A business valuation is based on the expected Return On Investment (ROI) balanced against the perceived sustainability and growth prospects.
- The multiple of earnings tends to increase if turnover increases as this tends to go hand-in-hand with a stronger management team and processes, reduced reliance on the owner or any one customer and, therefore, sustainability. So, businesses turning over £15m a year will earn a higher multiple of profit than businesses earning £1m a year.
- Businesses with recurring revenues tend to earn a higher multiple. Recurring subscriptions (often seen with SaaS companies), or companies that have lots of multi-year contracts (often seen with IT companies) and healthy sales pipelines will naturally attract a larger multiplier than businesses that sell services based on time resources (such as design agencies).
- Businesses that are demonstrating an upward trend and have further scope for scale and expansion tend to earn a higher multiple, with valuations based on the latest and projected earnings.
So, our advice for you here would be to make sure you're ticking at least the four boxes above to achieve the highest multiplier possible.
Develop an executive summary for your business
An executive summary is the document that, essentially, outlines exactly what the business is and does. It includes an overview of the financials too (see next step for more information on them), and possibly a useful FAQ section to help the potential buyer understand as much as they can about your company and why you value it at the price you do.
The more information you share here, the better. The more comfortable you can make your buyer feel, the smoother the selling process will be for you.
Prepare your financials
Arguably the most important step of them all. Get your financials in order. Your business will be valued on profit, so having your profit and loss reports clear and easy to understand, as well as up-to-date, will give your potential buyers more confidence that your business is performing as you say it is.
Buyers want to see how healthy your company is in regards to its finances, and the more complete and robust your reports are - reports that, critically, include monthly management accounts - the happier they’ll be and the faster they’ll understand your situation.
Nothing puts a buyer off more than a company with poor financial records.
Here are some pointers from our ‘Selling Your Business: The Ultimate Guide’ article of what a buyer will require to fully understand and be comfortable with your business:
- Up to 24 months of Monthly Management Accounts demonstrating a smooth growth and/or consistency through two years of revenue cycle (if your business has seasonal sales peaks for example).
- An integrated monthly P&L (profit and loss), BS (balance sheet) and Cashflow forecast model. The buyer will want to see what will happen to the business after they acquire it under different assumptions. So, the model needs to be assumption-led and show what the future profits, cashflow and balance sheets look like 2-3 years ahead under different assumptions on activity.
- Customer analysis, revenue breakdown and margin analysis for the last 3 years.
- Supplier agreements, customer agreements and contracts.
- Product analysis including strong performing products / services.
- Any capacity limitations.
- Capex analysis (what fixed assets do you have and how do they relate to the successful operation of your business).
- Statutory Accounts reconciliations. Do your management accounts tie into the Statutory Accounts filed at Companies House?
- Breakdowns of Working Capital requirements.
- Summary of “out of the ordinary” practices. Buyers don’t like surprises so it is better to reveal in a controlled manner any items that might surprise their due diligence team.
- Employee breakdown, employment contracts.
Find and target suitable buyers
The process of finding and matching business sellers to buyers is a complex one, and we would definitely recommend talking to a business broker about this step.
However, we do have some advice to share with you should you decide to do some research and outreach yourself.
The first thing to do is identify the different types of buyers, and they tend to fall into the following categories.
- Trade / Strategic buyers
- High net worth investors with industry experience
- SME Investment Buyer
- Private equity with management buy-in
- Entrepreneurs with spare cash
We have more information on each of them in our Ultimate Guide: Finding a buyer.
Finally, you must accept the state and decisions of the current market.
A business is only worth what someone will pay for it, and the valuation you come up with is simply a guide. As is the case with many things in life, the market tends to have the last say on the price of something. So you'll need to understand and accept that.
If your business has gone through a tricky period, then the likelihood is your business has lost some of its value and the market's opinion may no longer be in line with yours. This said, the impact of the coronavirus pandemic on your business may or may not be long lived. Based on the deals we completed in 2020, we have seen that serious buyers are taking a long term view.
If you're looking for a quick sale, or the company needs additional investment to survive, then the ball is very firmly in the buyer's court and, again, you must understand that their opinion of the business's valuation may differ quite drastically from yours.
Conversely, if your business is in a booming sector, and buyer activity is high, then you may be able to command a greater price for your company than you originally thought.
Essentially, the market will always fluctuate, so make sure you understand the current situation and prepare yourself for how it may affect the value of your company.
We hope this article has been useful for you, and we're happy to answer any questions you might have about selling your business.
You can contact us by filling out the form below, or by calling 020 8090 9380.
Thanks for reading.