Business Valuations 101

Hamish Mexted Business Strategy & Planning, Odds & Ends

At first glance, valuing a business is straight forward. It’s a formula with numbers from your Accounts. The complication is that we need to make an educated-guess about your future profit and operations, and make assumptions about things which may (or may not) happen.

The formula
Businesses are often (but not always *) valued by multiplying:

Your profit, after various adjustments

By

Your multiple

 Your profit
What we’re trying to work out is how much the business actually earns. This is after we strip out things which have gone through the business for tax which maybe shouldn’t have (like home office).

It’s then about adding in expenses which haven’t gone through the books but haven’t. For example, you might pay yourself a low wage as the owner of the business, when a fair market salary is higher.

Once these adjustments have gone through, then you should have an idea of how much profit your company earns on its own (i.e. independent from your involvement as the owner).

We then need to make assumptions around future profit. What we’re looking at is the probability of your historic profits continuing into the future.

Your multiple
Your multiple is the number of times annual profit you’re willing to pay for the business.

For example, if the business makes $200,000 per year, and you’re paying a 2 times multiple, then you’ll pay $400,000 for the business. You’re also saying you’ll need to run the business profitably for 2 years to get your cash back (before worrying about interest on your loan to buy the business and tax).

In general, the better a business is run, the higher the multiple. The fundamental strength of systems, staff, production, industry trends etc. is the core driver of the multiple.

But…

The value of a business doesn’t necessarily equal the price it’ll sell for. If you think of the property market, a property valuer will value the property based on recent sales in the area with an allowance for the particular features of the property. Valuing a business is no different – the price paid is only what someone’s willing to pay – the value is based on the business’s profit and fundamentals.

Increasing your value
The two ways of increasing the value of your business are to:

  1. Increase profit, or
  2. Increase your multiple

Many business owners find that strengthening the operations of their business to increase their multiple also increases their profit – stronger businesses typically earn more.

If you’re wanting to increase your multiple, a good place to start is by building your staff or documenting process.

But I can’t sell my business, can I?
All too often we hear business owners say they can’t sell their business. We completely disagree. They might be correct saying they can’t sell it today, but they definitely can in the longer term. We’ve seen all sorts of businesses sold, from manufacturers, wholesalers, bars and restaurants, importers, mechanics, builders, plumbing companies and more.

Every business is saleable. The proceeds from it are (generally) tax free, making it the cheapest money you’ll ever earn.

Next steps?
If you’re wanting to find out more about selling your business, click here go to our home page and click on “Selling your business”.

You’ll receive a series of emails over 5 weeks with the keys to selling your business – when to sell, how to increase your multiple, who your potential buyers are and making it all tax free.

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* Disclaimer:This overview is very high-level. The devil is in the detail, and particular businesses (like tech start-ups) and particular industries (like legal) are valued differently, or have a different valuation methodology. Please get in touch if you’d like more specific information.