Valuing your business for sale

Valuing a business for a sale or a range of other reasons can be a complex and often difficult exercise, but with the right advice and input from your trusted advisors it can be achieved seamlessly.

The process involves not only working with your lawyer but importantly also your accountant and financial advisors. It is a team effort to ensure the correct methodology is used.

As lawyers who act for a diverse range of businesses across different industries and professions, and it is always a rewarding exercise to assist clients undertaking this process in preparation for a sale.

Why value your business?

Whilst we are concentrating on a sale in this article there are a range of reasons you may want to value your business including:

• A merger and acquisition with another entity
• Planning the succession for the business into the future
• Estate planning for yourself, your partners and family
• Taxation related issues
• Ensuring compliance with regulatory issues
• A legal dispute

It is important to give consideration to what factors and issues affect the value of a business.

Whilst there is no exhaustive list, as each business has its own characteristics, these are some of the factors that must be considered:

• The financial performance of the business
• The market and industry the business operates in
• The future potential for growth, including financial and environmental factors
• The assets and liabilities of the business
• The employees and their importance to the business

Methods of Valuation

We always emphasise to clients there is no right or wrong method to value a business.

It will depend on the industry or profession the business operates in, its size, financial history and what the future is for the business.

In this article we will explore the range of valuation methods that we have been involved in when undertaking valuations for our clients.

Asset or book valuation

This looks at the net asset value of the business by considering the assets of the business and then taking away any liabilities which will result in the projected net income.

Simply put if the assets are valued at $2 million and the liabilities are $1 million it would equate to a value of $1 million.

Comparable sales method

This involves researching similar businesses that have recently been sold in their industry and location to provide comparable market transactions.

Discounted cash flow valuation

This method looks at Free Cash Flow (FCF) which is the net operating cash flow minus capital expenditures which represents the cash available from operations after funding reinvestments in the business such as maintenance or upgrades.

Earnings-based valuation

This method considers what the business makes for the owners and then using a multiple of the annual earnings.

For example, if the business was making $1 million and the multiplier was 3 the value would be $3 million.

We are often asked how you calculate the multiplier, and this can be very subjective.

In essence larger multipliers apply to businesses which have long term historic earnings, long term contracts, loyal customers or clients, significant intellectual property and unique business models. 

Earnings multiple

This looks at the business’s earnings before interest and tax (EBIT).

The EBIT is then multiplied by an industry-specific multiple to estimate the valuation.

For example, a business with an EBITDA of $1 million, with comparable EBITDA multiples of between 6 and 8 times, would likely be valued between $6 million and $8 million.

Entry-cost valuation or cost-based approach

This considers what it would cost to start a similar business.

For example, if it would cost $1 million to start the business that would be the starting point.

Adjustments are then made for such issues as the convenience of starting from scratch, the expenses associated with establishing a business, acquiring assets, developing products, recruitment and training staff, building a customer base amongst other start up issues.

Liquidation valuation

This is like the asset or book value, but with a subtle difference.

It considers the value if the business is closed, and all the assets are sold, and the debts paid.

The difference to the asset or book value is that it is based on the actual market value and not the strict asset or book value.

The market value is basically what someone would pay for the business.

When considering this method, it is important to consider which earnings model is used, being net profit or EBITA, as the later will always be a larger number.

Market capitalisation

This method is used for businesses which are publicly traded companies and can be referred to as the market cap.

By multiplying the businesses current share price by the total number of outstanding shares you will get a number which reflects the market cap based on the market’s sentiment.

This often does not reflect the actual value if considering the assets, liabilities etc and can be a volatile or short-sighted view.

Times-revenue valuation

Whilst like the earnings-based method, this simply considers the revenue and multiplies it by a specific multiplier.

The FCF is then used to arrive at the value by multiplying it by a multiplier.

Calculating FCF is not as straightforward as calculating revenue, EBITDA or net profit and is not common with small businesses.

How can FC lawyers help with valuing your business?

Whether you are contemplating selling or buying a business you can be assured our team have acted in thousands of transactions preparing valuations for a range of opportunities for our clients.  Our team will work with your accountant, bankers, and other advisors to ensure the correct methodology is used.

Contact our team today to discuss your legal business needs.