Business valuation. How much is your business worth?

We are frequently asked “What do you reckon my business is worth?”. And that’s always a difficult question to answer. The glib response is “we won’t know that until we test the market”. Or “it’s only worth what someone is willing to pay”.

Whilst true, that’s not very satisfactory, is it? For a range of very good reasons, you want a number!

Let’s play. If we say, “it’s probably somewhere around $20-$25m”, naturally, that number goes straight into your head. It will form the basis of all your calculations and what you are going to do when you sell. Where you will live, when you will retire, how much travel you can afford to do. Notice also that if you are like most people, you are drawn to the higher number of $25m! Were you?

“How much is my business worth?”. Ten different valuers are likely to give 10 different responses to this seemingly simple question. This frustrates business owners. However, there is no accounting standard, no agreed formula, only theory, methodology and history.

Business Valuation Methods

In determining what they think is a fair market value, valuers will select a methodology (or methodologies) they consider to be most appropriate. The following methodologies are widely used and may be selected for use if appropriate to the circumstances:

• The capitalisation of future maintainable earnings method
• The discounted cashflow method
• The net assets method
• The industry market method

Let’s take a brief look at how they work.

Capitalisation of Future Maintainable Earnings

The capitalisation of future maintainable earnings method is a reliable methodology to employ for mature profitable businesses where there has been sufficient trading history to establish business continuity and where it is reasonable to expect that the value of the business is likely to exceed the underlying value of the net assets of the business.

This business valuation method capitalises earnings (generally before tax and interest expenses) in order to establish a value for the enterprise. To arrive at a valuation, this method requires:

• Assessment of the future maintainable earnings of the business;
• Assessment of an appropriate capitalisation rate (or more commonly a multiple); and
• Deduction of the value of current net interest-bearing debt and an adjustment for the value of any surplus assets or liabilities.

Discounted Cash Flow

Valuers normally consider the Discounted Cash Flow method a superior technical approach. That’s because it allows for fluctuations in future performance to be recognised. It also values the business on the basis of the future free cash flows generated. To utilise this business valuation methodology, however, requires reliable medium to long term cash flow forecasts. Not all businesses are sufficiently predictable, or well established, to give confidence in those medium to long term cash flow forecasts.

To arrive at a valuation, this methodology requires:

• Quantification and assessment of the cash flow projections of the Company;
• Determination of a discount rate which is used to convert the future cash flows into a present-day value where the discount rate reflects both the time value of money and the risks inherent in the projected cash flows;
• Determination of a terminal value where the terminal value captures the value of cash flows occurring after the projection period into perpetuity. This value is discounted to a present-day value and added to the present value of the cash flows occurring during the projection period; and
• Deduction of the value of current net interest-bearing debt and an adjustment for the value of any surplus assets or liabilities.

Net Asset Backing

The net asset backing method, whilst valuable as a comparison tool, is generally inappropriate for valuing businesses under a going concern concept. This method assumes that the value of the business rests in its underlying assets. And that the value of those assets as recorded in the financial statements is a reasonable reflection of current value. It doesn’t consider the actual or appropriate level of return that would be expected to be generated from the assets.

Where a business holds significant amounts of fixed assets, the valuation of those assets under a going concern concept may vary from their realisable value and their book value. Furthermore, the this method ignores goodwill considerations. Or even the value of other intellectual property or intangible assets, unless the financial statements have recorded this.

Industry Market

The industry market method may be used in industry sectors where:

• There are a relatively large number of participants;
• The sale of these businesses occurs on a relatively frequent basis;
• The sale price and other financial information relating to the transaction is public.

In such sectors, current market prices can be established for similar businesses and flexed to allow for the features unique to your business. This can provide a basis for forming a reasonable market opinion.

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Selling your business can be a daunting experience. But if you stay on task and have the backing of a great advisory team, you can enjoy the process and be ready to start your after-business life. Contact one of our trusted business advisors if you’d like further information about selling your business.