A business has many values
Putting a value or sell price on a business involves assessing the cash that the business is generating for the owner and the risk to that cash continuing on under a new owner. It’s a case of return versus risk.
The cash component is relatively easy to work out. We do that from the financial reports of the business. It involves working out the proprietor’s earnings before interest, tax, depreciation and amortisation (PEBITDA) and before one owners wages, super and discretionary spending. This is usually averaged over three years. I prefer to call it the “maintainable adjusted nett profit”.
The risk is far more complex. It is a combination of many factors such as industry risk, owner dependence, location and lease terms, economic risk and many more things. Obviously there are also risks related directly to the new owner taking over the business. When I perform a business ready for sale assessment for an owner, I effectively do a due diligence exercise from a buyer’s perspective and look at the risks. If you want to know more:
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So why did I say at the beginning that a business has many values?
At the end of the day, a business is worth what a buyer is willing to pay for it. However, the seller / broker has to make multiple sales. From my years of experience as a broker and advisor, this is what happens in practice:
- The business owner forms in their mind what they think the business is worth based on how long they have been operating, or
- Or the business owner works out what they ‘need’ to be able to sell for – pay off debts, buy another business, retire etc.
- A broker or valuer uses the PEBITDA or other recognised appraisal or valuation process with market experience
- A buyer has their own idea what the business is worth based upon what they can afford or want to pay
- The buyer’s accountant or whoever is doing due diligence, comes up with their value based upon the financials but with little knowledge of actual sales in the market
- If finance is required to buy the business, the bank or finance lender will put their value on the business and who knows what they will come up with
- If the business is part of a franchise, the franchisor will have their opinion of the value as well – often inflated!
So, do you see what I mean? It requires the seller, the buyer, the buyer’s accountant and the finance lender (if required) to all agree before a sale can be completed. And they all have their own view of what the business is worth.
As a business owner you need to have a starting point. I recommend PEBITDA plus market experience as being the most reliable value and work things out from there. Then know what you can do to make the business more valuable and saleable.
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