Article 3 in our Exit Planning series
Once you have identified a set of consistent objectives like your personal, financial and business goals (see Article 2) to help define your exit strategy, it is time to think about valuations.
It is understandable to get excited about valuing your business. This is the golden moment for you and the crystallisation of all your hard work. Coming up with a common-sense value to meet your future goals requires clear thinking and good advice. Objectivity is rarely factored into the early stages of the valuation process.
Valuation methodology is helpful and there are several useful tools to estimate what your business is worth. These tools can help eliminate the “roll a dice” approach a surprisingly high number of outgoing owners still use to value their businesses, for example basing it on what you have “heard” a similar business to yours sold for, without comparing similarities and differences.
The first three questions we always ask our clients to consider are:
- What do I need it to be worth? Having considered your personal and financial goals, what do you need your business to be worth to achieve these?
- What is it worth? Whilst you need it to be worth $X to meet your future goals, what is the fair market value for a business such as yours operating in the way that it does?
- What could it be worth? If your business was trading at the top end of profitability for your sector and operating excellently, what premium could you get?
Fair Market Value
Finding out the fair market value for your business can be achieved using different methodologies, but let us start with a common rule of thumb.
EBITDA × Multiple = Value
That is the Earnings Before Interest, Tax, Depreciation and Amortisation multiplied by the Multiple a buyer is willing to pay for your business, which gives its Value. The Multiple will depend on the level of competency your business operates at and the industry it is in.
This rule of thumb gives a quick indication of value but does not consider business-specific information that will impact the business above and beyond industry benchmarks. We happily use this rule of thumb with our clients as a starting point, but at a later point in the journey we encourage them to get a professional valuation.
Professional valuation
The potential variations from the above calculation are endless and some businesses, for example non-profitable businesses or start-ups, are ill-suited to this rule of thumb. A professional valuation will steer you through these variations to arrive at a suitable value. Here are some of the things you should expect them to consider in their judgement:
- Industry and economic outlook
- Nature of the business and its operating history
- Transaction prices of other companies engaged in similar activity
- Book value and financial condition of the company
- Value of intangible assets
- Earnings and dividend-paying capacity
- Market prices of public companies engaged in similar activity
Whoever does your valuation needs to ensure the purpose of your valuation is kept in mind. Whilst there are different reasons for a valuation, such as investment or debt restructuring, shareholder transactions or benchmarking acquisitions, we are talking about exiting or selling your business, so your valuer should be looking at methodologies that establish fair market value.
What if you get a low valuation?
If your valuation indicates that your business will not sell at the price you desire, you can work on increasing the multiple you receive. In achieving a fair market valuation, your valuer will have ranked your business on several metrics. Which ones did you perform well on and which ones did you perform poorly on? If they are not able to provide you with these metrics, you can undertake a self-assessment based on a number of ranking tools.
When we undertake a Financial Discovery Roadmap as part of a CFO engagement with clients we conduct a diagnostic to understand where a business is weak and what factors we can change to improve the business and its value. Assuming time is not a major factor, we recommend playing the long game to create value. Use the information at hand to make high-quality decisions about your business, identify weak areas and set up the processes and systems to get stronger results and make your business more valuable.
We will cover in detail what drives value in part four of this series.
Value vs saleability
Once you understand the value of your company, you also need to understand how saleable your business is. A profitable business does not always mean you will be inundated with offers. Similarly, value and saleability are not always mutually exclusive.
Saleability determines how quickly a business will sell and how much leverage a business owner will have when negotiating with a buyer. Saleability depends to a large extent on the external market and financial conditions, which can be out of your control.
What you can control are the mechanisms and systems you already have in place which made your business a success in the first place. Maintain and improve these. In our experience, the owners who do well are the ones who do not rush into hasty and reactive business decisions. Take a strategic mid-level approach, strengthen the management team to reduce reliance on the owner (buyers want to buy a business, not an owner) and reduce cash flow pressures where you can.
Making wholesale panic changes is something you would not do in the day-to-day, so there is no reason to hit the panic button now. You can drive up value by thinking about the things you do well as a business. Make use of the intellectual property you have or an excellent product that sells well.
Develop a healthy mindset, listen to your advisor and remember that a below-expectation valuation gives you a basis to improve. Take ownership of the valuation and gradually implement changes to get your business into the best possible position. Your exit will happen and your strategic advisor will be able to help you achieve the best outcomes for you and your business.