Valuing a Business
“What a business is worth is basically a combination of how much money a buyer can make from it weighed against the risks of achieving that profit.” Asset valuations start from considering the balance sheet and identifying all the assets (and liabilities) and refining the values disclosed by considering what the current market values are. For example, property may have changed in price since it was bought; some stock may be old or slow moving and therefore not worth its carrying value; some debtors may not be collected or bad debts may have been conservatively provided for; and leases may have dilapidation claims from landlords attached to them. By working through these you can come to a value for the assets. But if, for example, you are closing a business to realise the property value, you may need to take account of redundancy costs, cost of closing the premises and the fact that debt recovery will be more difficult. Price/earnings valuations are more typical for most businesses. The first thing to do is work out what the enterprise value is (the value of the business), and then work out the equity value (the value to the owners). The two fundamentals in calculating the enterprise value are to calculate the profit and then source a relevant multiple to get to the final valuation. The first of these may seem simple but consideration needs to be given to what are referred to as ‘underlying sustainable earnings’. Some costs and income may be exceptional by nature, and other costs may be ownership costs – for example excessive remuneration. All of these need to be identified and added back to the profits. At the same time you need to deduct any costs that will be needed to run the business once it is in someone else’s hands. For example, many owners take remuneration by way of dividends, so deducting a market value for their salary, albeit possibly at a lower level of seniority, is important. Having calculated the profits, the next thing to do is look at the multiple – that is the
number of times that the profit will be multiplied to arrive at the value.This is done by looking at comparable listed companies; researching recent transactions; and/or looking at other published data. As a rule of thumb, the recent ICAEW Valuations Conference estimated, using the Dohmeyer, Butler and Burkert analysis, that for deals of £3m to £36m, the average EBIT multiple was between 5.4x and 6.4x. Once an enterprise value has been calculated, to get to the equity value you must deduct any excess or hardcore debt and add any excess cash. For example, if the business has undergone a previous management buyout and still owes £2m, this would be deducted by the buyer. Also, many privatelyowned businesses have hoarded more cash than they need on a day-to-day basis in the past few years which could be returned to owners by way of a distribution, and so can be added to the enterprise value to arrive at the equity value.
Contact Details: EMC Corporate Finance Ltd, Rochester House, 48 Rochester Gardens, Hove BN3 3AW Contact: Michael Pay, Director Tel: 01273 945984 Mob: 07958 414956 E: michael.pay@emcltd.co.uk W: www.emcltd.co.uk
Discounted cash flows are less common amongst SMEs but still relevant for larger corporates or where sustainable cash flows can be ascertained such as in licensing agreements. The methodology is fairly simple. First, calculate the future cash flows that will be derived from owning the business or asset. Then apply a discount rate to those incomes based on the risk associated with achieving them. The lower the risk the lower the discount rate and, conversely, the higher the risk the higher the discount rate. And finally, having said all of that, there is no better way to work out the true value of a business than for the market to value it. In the end the value will always be determined by a willing seller dealing with a willing buyer and what they end up agreeing. By properly preparing your business and then carefully selecting likely buyers, you will not only be able to know what your business is worth but, if you choose to sell, be able to enjoy the spoils of all your hard work!
- Valuing a Business -
Issue 4 � 2014
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