What’s it worth?
Article Date: Mar 02 2006
Pricing companies is a dark art. Your valuation and that of potential buyers are unlikely to tally, yet value it you must before you can begin any sort of sale negotiations.
Unfortunately, there are no hard and fast rules when it comes to determining the value of your enterprise, particularly a private business, but there are some guidelines suggested by those in the know.
As a crucial starting point, you need to be clear in your own mind about the amount you wish (or need) to realise and the best way to manage the sale ahead of exit negotiations.
But – and it’s a big, obvious but – your business is only worth the sum a buyer is prepared to pay, so you and your advisers should try to be objective. Aside from the financial calculations you can make, you will want to incorporate some estimate of inherent value, from goodwill or established systems. Here, it’s all too easy to be blinded by an emotional attachment into believing your business is worth far more than it really is when passed on.
Another consideration at the start is whether you and other key staff will be staying on as part of the sale or if you wish to exit the business entirely. This can be a major factor determining value.
Helpfully, there are a variety of valuation models used by different industries and sectors, which can give you an ‘objective’ measure of the worth of your business.
Price earnings issues
Various earnings multiples can be used as a pricing guide. Price-to-earnings (p/e) ratios are the way the City, on the whole, compares differing companies in the same sector. As a widely used valuation measure of the relationship between a stock's price and its earnings per share, it is also referred to as ‘multiple to earnings’ or simply, ‘the multiple’. It is calculated by taking the current stock price per share and dividing that by the most current earnings per share.
It’s an important tool for investors as it indicates how much they are paying for a company's earning power. The p/e ratio may either use the reported earnings from the last year or employ a forecast of next year's earnings (aka ‘the forward multiple’).
Assuming your business has a track record of profitability, a valuation can be worked out by multiplying profits by the average earnings multiple which companies in the same sector command. In the publicly-quoted sphere, profits are typically adjusted for exceptional items to arrive at an estimate of normalised earnings.
It’s worth noting that certain sectors are more highly rated than others. For instance, companies in the industrial transportation sector attract average p/e ratios of 34, those in leisure goods, 28 and those in media, 19. If you’re in industrial metals though, the average p/e is a lowly seven.
Moreover, if yours is a private business, you will almost certainly have to settle for a lower multiple than a quoted peer, since listed companies can be more easily bought and sold.
Other valuations
‘Selling a business is not like selling a house,’ says Howard Leigh, managing director of prolific and private business-focused Cavendish Corporate Finance. Leigh, a frequent lecturer on mergers and acquisitions, says there are countless ways of pricing a business, ‘based on profits, cash flows, assets, and sectors. Even with profits, the question arises, which profits?’
For more mature, cash generative businesses, a discounted cash flow analysis is recommended as the norm when trying to value a business at sale. In short, this is based on the future cash flows of your business. If you own a stable business with large tangible assets (such as plant and machinery used in heavy manufacturing businesses), then a valuation based on its assets could be used. Your net book value, refined to reflect recent asset value changes or bad debts, will be a good guide to the saleable price. Variations on book value are often used when an earnings multiple doesn’t apply, such as when your company is loss-making.
An ‘entry cost’ valuation, the cost for a rival to set up in your space in terms of buying equipment, employing staff or developing products, might also appeal. However, if entry costs in your industry are low, you are unlikely to successfully sell based on this. Ultimately, why would they buy your business when they could set up for themselves for the same cost?
