Valuing a Business for Sale

Company valuation is often regarded as something of a dark art! 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 that give the process some efficacy.

As a seller your valuation and that of potential buyers are unlikely to tally but you must have a starting point before you can begin any sort of sale negotiations. It is crucial that you are clear in your own mind about the amount you wish (or need) to realise and the best way to manage the sale.

But  and its a big, obvious but  your business is only worth the amount a buyer is prepared to pay, so you and your advisers should try to be objective. Apart from the financial calculations that can be made owners usually want to add some estimate of inherent value based on goodwill and established systems. It is all too easy to be blinded by an emotional attachment into believing your business is worth far more than it really is.

Another consideration at the start is whether you will be staying on as part of the sale and for how long. Or you may wish to exit the business entirely. This can be a major factor in determining value and the structure of the deal including any earn-out provisions.

Related: Valuing a Corporate Recruitment Agency

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. In the Recruitment field, being a purely services based industry there are less established rules of thumb that apply than most. It would be fair to say that there are no set rules and your company's value is as much or as little as you can negotiate. It is interesting to list some of the valuation methods that are used in different cases across a range of industries:

Adjusted Book Value

A valuation based on the assets and liabilities of the business

Asset Valuation

Used for business with a lot of physical assets, for e.g. manufacturing.

Balance Sheet Method

Often used when businesses are losing money. Based on current asset worth.

Capitalised Earning

Based on the rate of return in earnings.

Cash Flow

Based on how much financing one could get using the cash flow of the business.

Debt Assumption

Based on the level of debt that a business could have and still operate using cash flow.

Discounted Cash flow

Discounts projected future earnings to adjust for growth, inflation and risk.

Liquidation Value

Similar to Adjusted Book method.

Multiple of Earnings

A common method that uses cash flow to calculate worth.

Market Multiplier

Common in Recruitment, it uses industry-average values from recent business sales as a multiplier.
In the Publicly Listed Company arena it is usual to compare them with other companies in the same sector using a Price-to-earnings (P/E) ratio. This is 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. 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) In the Recruitment field it is quite common for companies to determine a valuation multiple based on those that like-companies have achieved.

Common Misconceptions

Selling a business is not like selling a house. But this analogy is frequently used by both intending business buyers and sellers. Unlike the residential property market, as we have seen there are many ways of pricing a business. These can be based on profits, cash flows, assets, and sectors. Even with profits it is often likely that a normalised profit (EBIT) needs to be determined which takes into account the exceptions and practices that business owners might quite justifiably have in place such as the level of salary they pay themselves, loans, one off expenses and a range of other items.

Another common misconception and probably one of the most difficult to overcome is the goodwill factor in recruitment company valuations. Years of hard work to build a business up do not of themselves increase a valuation. There is no sweat equity unfortunately! The impact of the work done in previous years should all be reflected in current levels of profitability. Similarly if the database you have developed and the systems you use are effective then they should be currently impacting on the bottom line.

In other words if these things have added value it has been to your level of profit and hence the figure that is subject to a multiplier will be greater. However, it is often argued by sellers that as a result of this background effort that a higher multiple should apply.

A third misconception is the comparison of private companies to publicly listed companies. The publicity surrounding Listed company acquisitions is obviously more widespread. This leads to incorrect assumptions about the value of multiple that may be achieved in private company transactions. As a private company you will not achieve the level of multiple that may be quoted for publicly listed companies as these companies can be more easily bought and sold via the share market.

Timing is Everything

It is important to smell the air and be aware of the economic and market trends. If you are a potential seller the value you achieve depends on selling at the right time. Macro factors, such as the state of the economy and conditions in your sector at the point of sale, will come into play, not to mention the question of supply and demand. How many genuine buyers and offers are likely to be achieved?

Remember too that in most circumstances buyers will want to factor in an amount of deferred consideration (earn-out provisions) so you may have to think about the economic circumstances of 12 months or even 24 from the time of your sale. Its also worth bearing in mind that strategic buyers, motivated to assume geographic advantage or access to a new customer base and market segment, are likely to pay more for your company than others.

Article Written By Richard Hayward of HHMC