In order to exit a business, detailed planning is required. The valuation of the business is key to extracting wealth. Although a business valuation involves some number crunching, the real challenge for many is to arrive at a value that all parties agree is fair. Whilst the conclusion may be simple, the factors that go towards that result are complex. Terence Gale, Menzies business valuations expert, highlights some of the important aspects of valuation and their interaction with exiting a business.
At some point every business owner will want to “exit” their business. This may be a voluntary exit or involuntary due to death or incapacity. In both circumstances there is a need for a proper business exit planning strategy; proper exit planning should be an important part of a business owner’s financial and estate plans. The first step in creating a viable business exit plan and strategy is to determine the owner’s long term income needs and retirement goals. From this, the owner will be able to determine how much money is needed from the sale of the business.
Valuation for business disposal
The main aim in any valuation exercise is to arrive at a price that takes into account all the relevant information at the valuation date that would be needed by the parties to arrive at the appropriate value. Some of the principles used in a valuation may be dictated by accepted practice founded upon case law and some of it will be based upon market circumstances.
However, the one overriding factor to bear in mind is that each case is different and it is not a process of using a simple mathematical model. Once business owners understand that the valuation is bespoke and unique, they are then only really beginning to enter the realms of considering how they can maximise the value of their business at the point of exit.
The starting point in all cases is to consider how the exit is going to be achieved. Will it be through sale to a third party, through a management buy out, through family succession? In considering the valuation of the business at exit there are certain points that must be considered. For example, if a shareholder has a minority interest of say 30% of a company, in a straight disposal of that 30% it will not be worth the same as 30% of the whole due to the inability of the holder to control their destiny and the need to value on an open market value basis.
When is the right time to value and exit your business?
Once the owner’s time frame for leaving the business has been determined, the owner should examine the pros and cons of selling the business to an outside third party or insiders such as family members or key employees. The type of purchaser will dictate future employee compensation and incentive packages and tax planning strategies for minimizing capital gains. Another crucial aspect is the effective date of the valuation, particularly if there needs to be an information cut-off for determining the value. In the context of an open market sale of the company the date is vital, bearing in mind how external factors change and impact on the valuation. For example, witness the impact on the market of difficulties in the Eurozone. Therefore, thinking and planning well in advance of a sale in order to maximise the value is crucial – this may mean planning up to three years in advance.
Factors affecting valuations
Important for any business owner are the key drivers that determine the structure of value and ensuring they are controlled (so they impact favourably to maximise any price on sale). Some are beyond your control, such as declining industries and low barriers to entry, but many are not.
Dependency on a few key customers or suppliers dealing with the business will create added risk and can impact significantly on the business and hence its value. The key, as it would be from a commercial viewpoint, is to spread the risk so that no one customer failing or supplier change in terms would materially impact on the earnings capacity of the business.
The growth of earnings, of either a constant or increasing trend, will paint a good and confident picture and will underpin a favourable value. Whilst maximising earnings in one year is good, if this is at the expense of the subsequent year so that the graph goes up and down, this will not achieve the same price, since a would-be purchaser will become nervous. Therefore, robustness of earnings is a typical phrase considered and a maximisation of value goes beyond that to show a rising and confident trend.
Many other factors will influence the value and quite often the ability to demonstrate the earnings growth in the development of the company for future expectations through products or expansion of the customer or supplier base.
The evaluation process
In considering the valuation process, a typical approach would be to consider adjusted assets, dividend return and earnings, or a mixture thereof. Certainly, for an investment company it is the assets, such as property or a share portfolio adjusted for present value, that are important. Additionally, if acquiring a minority interest in such a company, the dividend yield may be more important to a prospective purchaser. That may be the only route for the shareholder to obtain a return on their money as they have no influence on a sale.
A service company would typically be valued according to the earnings of the business. The need would be to arrive at the maintainable earnings of the business, which may be based on history or the foreseeable future, and to consider a capitalisation of those earnings by the application of a multiple.
That multiple would be affected by outside influences, such as interest rates and general markets, but would also depend on company-specific matters like the graph of earnings. If the graph is on a steepening upward curve, the multiple is likely to be higher than for a static growth curve for a similar business. It must not be forgotten that the converse of the multiple is the return to be received, and the higher the risk the higher the required return.
Overall, there is no precise way of establishing the value of a business. Each company is different and many factors go into the pot when evaluating what is fair and reasonable. The aim is to control as many factors as possible with a view to reducing risk and thereby maximising return. In the end, whilst some aspects can be formulated, the final test is to stand back and consider whether, personally, you would sell or buy at that price. If not, then the result is probably not right.
Having acted for both buyers and sellers, we have seen both sides of the coin and understand the emotional highs and lows involved with business valuation. A trusted adviser will identify the likely interested parties, approach the market on your behalf and seek to ensure that the price is maximised while you continue to run your business as usual.