I get approached by people all the time who want to sell their businesses.
That’s great – but there’s almost always a problem …. what the owner thinks their business is worth.
Here’s a brief history of recent valuation multiples:
- In 2005-2007 you could get anywhere from 5 times to 1o times EBIT for a company.
- In 2008 you were lucky to get 2 times EBIT.
- In 2009 cautious optimism emerged, and you could get 3 times EBIT.
- So far in 2010, the valuation trend is still in the 3 times to 4 times EBIT multiples but steadily rising.
In some instances for IT companies – particularly in the US (of all places, given how bad their economy is) – I’m even seeing 6 times to 8 times EBIT for recognition of Blue Sky. I hasten to add that I think those valuations are in the minority and the new owners will have to wait for a number of years to realise the value of the businesses that they’re purchasing at those sorts of multiples.
Anyway, what are some factors affect the business valuation:
- Is the business profitable ?.
- Has the business been profitable for at least 3-4 consecutive years ?.
- Has the business been trading for more than 5 years ?.
- Is there a strong management team in place ?.
- Are there at least 3, but not more than 10, shareholders ?.
- Is the Gross Profit better than 30% of the Total Sales $$’s ?.
- What % of Total Assets are the Contingent Liabilities (eg: Annual Leave, Long Service Leave …etc) ?.
- Is the business a dominant player in a particular segment (ie: 1st or 2nd), or just a bit-player ?.
- What % of Total Revenues are coming from Annuity contracts ?.
In general terms, what INCREASES the value of a business (ie: beyond a 3 times EBIT multiple):
- Gross Margins above 40%.
- Gross Profit above 25%.
- Cost of Customer Acquisition below 5% (typically new business through existing relationships).
- A strong management team, with the Owner/MD/CEO being a good delegator.
- An existing Board of Directors, with good Governance processes in place.
- Brand Name clients.
- Annuity revenues, in long-term contracts, making up more than 25% of Total Sales.
- A Unique, or Near-Unique, offering that creates a barrier to entry for other competitors.
- Possession of protected Intellectual Property (patents ..etc), that has strong commercialisability.
- The company has loyal, well compensated and rewarded, staff.
In general terms, what DECREASES the value of a business (ie: below a 3 times EBIT multiple):
- High cost of sales (above 10% of Total Revenue), indicating low levels of repeat business.
- A large amount of Contingent Liability on the Balance Sheet (eg: Long-service & Annual Leave).
- The business has been trading for less than 2 years.
- The business is not profitable, or no longer profitable.
- The business is in a highly competitive, and largely undifferentiated, services sector.
- The business has only got 1 key client.
- The business has pending litigation, or has been recently forced to settle a claim.
- The business has more than 10 share holders.
- The business has a sole Director when it should have a proper board.
- There are irregularities in the Financials, commonly caused by a change in Business Strategy.
- The business sales cycle is measured in quarters, not in weeks or even months.
- The business value proposition is unclear.
- The website is rubbish and/or out of date.
- The company has a history of staff turnover.
Now, don’t get me wrong, just because a business has a number of “negative factors” doesn’t necessarily make it a bad business …. it just makes it a business that needs to be much more realistic about what its worth when looking for a buyer. For in the incoming owner (the buyer), there’s plenty of upside for them …. because they can tidy up the business issues that affect the valuation and make a tidy profit quickly (a la the Private Equity model circa 2006/07).
Please feel free to contact me if you have any further questions, comments or would like a valuation of your business done.