Article:

Business Valuation

15 November 2014

How much is my business worth?

Among the plethora of complex issues which must be negotiated in business life, there are few that are more complicated or subject to misinterpretation and confusion than a business valuation.

You can value a house based on its condition, its location, the number of rooms and the amount comparable properties have sold for. You can value a painting on the reputation of the artist, the quality of the painting and auction prices for similar works.

But these are tangible values and, while most businesses have things that can be discreetly measured there are many intangibles too, from copyright and intellectual property to brands and patents, and many other business assets that can add to a company’s value.

The constant in this process is that the valuation of a business is predicated on profitability or expectations of profit in the future. The value of any business is the value of its future cash flows. Profitability is then used as an indicator and proxy for future cash generation.

However, apart from this underlying core, the valuation process can swiftly splinter into a vast range of variables.

Business owners may need a valuation on their business for any number of different reasons. It might be for mergers or acquisitions, corporate restructure or as part of reaching agreement over a dispute, estate or divorce litigation. It could be due to impairment testing, new accounting standards, refinancing, an employee share scheme or as part of a long-term strategy to prepare the business for a future sale.

It is not only large or established businesses which seek business valuations. Start-ups often require valuations in order to raise venture capital or government funding and family businesses sometimes require them for a transfer of ownership.

A common misconception is that business valuations are simply based on a formula. It’s correct that valuations of an owner’s interest in a business are calculated based on various formulae and on multiples, but there are many different approaches. Equally, there are various different sources providing business valuations – from real estate agents to business brokers and DIY online options.

Add into this already highly complicated equation the vast range of different types of businesses requiring valuation – from those which are asset-heavy, such as manufacturing or retail, to others which may be weighted towards intellectual property, such as software companies.

Furthermore, many layers of a business might need to be assessed to reach an overall valuation. There might be investments, shares, employee share options and leasehold interests to name but a few.

A common area of confusion for business owners is also the difference between the value of the shares and the value of the business.

The business is valued on the future cashflows and potential profitability. The value of the shares, however, is based not only on the business/ enterprise value but also the market values of any other non-business/ enterprise assets and liabilities of the company. One must also take into consideration issues such as liquidity, any obligations or liabilities associated with those shares and any other arrangements around the transfer of those shares in the future.

It is this complexity, this extensive range of options and variations, which can be confusing for even the most experienced businessperson seeking a valuation of their business.

For instance, you might be talking to someone at a social event and they mention they have sold their business for “seven times.” Understandably you might think “well perhaps I can sell my business for seven times too” – one aspect of the professional valuer’s role is managing client expectations.

The question to ask in that situation is ‘seven times what’? Was it for seven times its Earnings Before Interest and Tax (EBIT); or was it a multiple of EBIT and Depreciation and Amortisation (EBITDA); or perhaps seven times Net Profit After Tax (NPAT)?

It could have been any of these, or others – and, for that matter, was it last year’s EBIT, normalised EBIT or this year’s EBIT?

There is no one size fits all model for assessing the value of a business. Ultimately the best model to use depends on the individual business or sector, it may depend on the purpose of the valuation and it could even be that a bespoke model is needed.

EBITDA is more commonly used for retail valuations – food manufacturing and distribution businesses, for example, have been known to use EBITDA for acquisitions. NPAT is often used for banks and finance companies, while multiples of revenue vs profit might be more suitable for businesses with extensive intangibles and no current profitability from which to project future profits, such as Xero or Amazon.

An effective, accurate business valuation won’t be achieved through an off-the-peg solution. The process requires legal and technical knowledge, practical experience and business acumen.

The best way to achieve the most effective business valuation is by using a valuer with extensive knowledge of different valuation models and the wide range of businesses they can be applied to.  BDO valuation experts can refer to a transaction database of 13,000 clients and company transactions, valuations and decades of experience assisting owners, shareholders, buyers and sellers to navigate the valuation of businesses.

In valuing a business we also consider:

▶ Business operations and structure

▶ Appropriate valuation methodologies

▶ Key drivers of business value

▶ Financial forecasts/business plans

▶ Integrity of underlying data

▶ Market analysis

▶ Taxation implications

▶ Timing and state of business growth

If your financial adviser is not experienced in dealing with the complexities of business valuation or if you require an independent valuation (e.g. for the sale or transfer of a business), it may be appropriate to seek support from a company with specialist corporate finance knowledge and expertise in company valuations.

For those who are considering selling or merging a business, it is crucial to work with a valuer who can cut through any confusion.

So all profit is the same right?

Accountants utilise a range of different assessments of profitability when assessing the value of a business or stock. While any of these should generate the same answers in terms of the total value, it is appropriate to understand which is most applicable to the business being valued.