When we first start the process of preparing a client’s business for sale, the first question is usually “How much is my business worth?” followed quickly by “How can I increase its value?”
The difficulty, in answering these questions, is that valuing a business is to a degree, more an art than a science and the answer is actually, ”it depends”.
Ultimately, and it may sound cliché, but a business is only worth as much as someone is willing to pay for it! Experienced acquirers of businesses are masters of setting the rules to calculate the value of a business they are attempting to acquire. But forewarned is forearmed!
Unfortunately, there is no single formula that can be used to precisely value your business. There are, however, a number of tried and trusted techniques which can be used to determine an indicative value for your business. Of course, the seller will want to drive the price up and potential buyers will want to drive the price down, so the final value will be down to negotiation between both parties.
Which formula is most appropriate for your business will depend on several factors:
- What are the circumstances of the valuation? A healthy ongoing business? An approach from your main competitor? A business prepared to maximise value? A forced sale?
- How tangible are the business assets? Most technology companies will have no real tangible assets beyond an office whereas a semiconductor fabrication plant will have significant tangible assets.
- What is the age of the business? Is it a young, innovative and scaling business or a mature company with an established and dependable revenue flow?
- Which technology sub-sector is the business in? IoT? Big data? Biotechnology? SaaS? Renewables technology? Values in each sub-sector will vary widely. The Barriers to entry in some sub-sectors are low, enabling competitors to quickly get a foothold thereby potentially reducing your business’ value.
- How valuable are your intangible assets? Some of the most valuable parts of the business may not appear on the balance sheet, for example, trademarks, reputation, branding, key people, size and quality of the customer base while others such as patents and IP may not be recorded on the balance sheet at actual perceived market value.
- Is the business dependent on the owner? Owner dependence is one of the most important factors in valuing (and marketing) a business and different buyers will have a different perception of the risk – much of the value in an owner-dependent business is destroyed if the owner leaves abruptly.
- What is the current economic climate? This has always been a ‘buyer’s market’ but Brexit, for example, has introduced an increasing degree of uncertainty which has led to delayed decision making on some transactions.
Use two business valuation methods to determine the value
When valuing a business, it is usual to use at least two methods and arrive at a value range rather than one definitive figure.
Method 1: Multiple of profits (or Price/Earnings ratio)
This is a good technique for companies with a solid track record of profitability but ratios vary widely. According to the ICAEW, a small unquoted business is usually valued at between 5 and 10 times its annual post-tax profit and a quoted company with excellent prospects may reach 20.
For certain innovative and high growth technology firms, the P/E ratio has risen dramatically, such as Facebook which had a P/E ratio of 114 at the time of its IPO. While such companies are seen as the exception rather than the norm there has been a trend towards normalisation of P/E ratios within the technology space and most growing technology companies are now commonly valued in the 10-25 P/E multiplier range, but again every company and sector will be slightly different.
Method 2: Asset valuation
This method is used for asset-rich businesses, and is generally not so relevant to the technology industry, although a biotechnology or life science company would probably be an exception to this rule.
To calculate your asset valuation, take the value of your assets and subtract your liabilities. This method of valuation usually produces the lowest valuation because it does not take into account the potential for future earnings.
Method 3: Entry valuation
What would it cost to start a similar business from scratch? Tricky figure to come up with this one. You’ll need to calculate the cost of employing people, delivering training, developing products and services, building assets and a client base.
Method 4: Discounted cash flow
This method uses estimates of future cash flow to value your business. It is the most technical way of valuing a business and depends heavily upon assumptions about long-term business conditions and is more appropriate for industries such as utilities, oil and gas or banking where income, expenditure and growth tend to be relatively stable. That said, McKinseys recently argued, in their article (Valuing high tech companies) that it might feel positively retro to apply DCF valuation to hot start-up technology companies, but it is the most reliable method.
Method 5: Rule of Thumb
Different industries have their own rules of thumb to determine your business’ value. For example, retail companies are generally valued as a multiple of turnover and/or the number of customers or outlets. Technology businesses, on the other hand, are quite often valued based on the number of customers/subscribers, the stickiness or customer retention and the uniqueness of the IP, patents or technology platform that has been built. Usually each of these factors will be given a weighting when calculating the value of the business to be sold but the extent of the weighting of these factors will be heavily impacted by the potential synergies they provide for the buyer, the current market sentiment and the ability of the seller to demonstrate the future growth or profitability of the business being sold.
Remember though that every business is unique and that valuing anything this individual is akin to ‘sticking your finger in the air’. A valuation is an indication and a starting point. Something that offers can be assessed against.
Make sure you really know your market
Before you start planning your exit, research your market. What have businesses similar to yours sold for? To whom? Why? Get to know as much about your market place as you can and be clear on what your place is within is. A lot of this information is publically available on the internet and most advisory firms publish quarterly reports which will provide an interested seller with the necessary information they need. If you already have an adviser or have worked with one in the past, then it would also be useful to have a preliminary meeting with them as they will be able to provide you with a more in-depth insight into the M&A market and the possible valuations that your business could achieve.
Prepare your business for sale and increase your valuation
The more confidence a buyer has in your business, the more attractive your business will become and the higher the price they are likely to offer.
A well thought through business plan in place
The first step is, therefore, to ensure that you have a well thought out business plan in place in which you have set out a clearly defined strategy.
A capable management team
A capable management team, which can clearly demonstrate a strong record of operational and financial performance over several years is vital. If your business is too dependent on your own skills, it might damage the price it can fetch – and could even make it impossible to sell. Making sure you have appointed the right managers, or at least have a succession plan in place, can enhance a company’s value by alleviating that risk. You may also want to encourage key employees to stay by considering appropriate incentive schemes, this will also ensure that they are incentivised to achieve the maximum value of the business at exit.
Reduce dependence on customers and suppliers
It is also important to reduce your dependence on too few customers or on one or two key suppliers. Show how your customer base is expanding and formalise any informal deals you have with customers and suppliers to provide the buyer with additional assurance about the business that is being bought.
You should also ensure:
- You have clear ownership of any intellectual property or patents
- All your management information systems are up to date
- Your finances are up to date and that the latest financial accounts are available
- You’re complying with health and safety, employment and other legislation – consider asking your legal advisers to review the business
- You have settled any outstanding legal disputes and ensure that any information pertaining to past legal disputes is available (as this will be required as part of the due diligence process)
- Property, employment, customer contracts are sorted out and up to date
The sooner you start planning, the more effectively you can do all this.
Be flexible and co-operative
Throughout the sale process, continue to demonstrate that you will be flexible and co-operative. In some cases, the buyer might require the seller and the existing management team to stay on for a period of time after the business has been sold. If you think it will help the sale or that the buyer will require it, then be prepared to work for the company for a fixed period after the sale is completed.
Get an adviser
If you are serious about selling, please get an adviser.
Understanding the steps of selling a business is relatively straightforward, but knowing how to value a business and effectively market a business is something completely different.
In a perfect world, the best time to involve an M&A adviser is at the beginning, whilst you are still thinking about selling your business. There is then time to prepare the business properly to maximise its value. Of course, no two sales are the same and this isn’t always practical, as you may have received an unexpected approach, for example. So we would say the earlier the better but whatever stage you are at it is never too late to bring in an M&A adviser.