Building a successful business is hard work, and when you’re considering selling, you don’t want to go into negotiations without a realistic idea of what your company is worth.
Even if you never want to sell, you still need to think about value – there’s succession, inheritance, wealth management, and insurance to consider. Is it worthless without you or are you sitting on a little goldmine?
“There are a few rules of thumb when it comes to valuing your business, and they’re typically wildly inaccurate,” says Aaron Toresen, managing director at Link Business Broking, New Zealand’s biggest business brokerage. “They’re okay for getting into the ballpark, but dangerous when it comes to real numbers.”
The value of your business hinges on a number of factors; from the obvious, like profitability, to the unexpected, like how replaceable you are. And some of those factors, like longevity and potential, aren’t as attractive to a buyer as you might imagine.
How much is it making?
The big factor is profitability: it’s never hard to sell a cash cow. Simply put, the more money your business makes, the more it’s worth.
Valuing your company requires taking into account not only what your company turns over annually (its earnings before interest and tax, or EBIT), but how much money you take out of the business. Your drawings or salary, known as seller’s discretionary income or earnings, can be an important part of the value, particularly in a smaller business where the new owner will be a hands-on manager.
Once you know the company’s earnings, then a business broker can help you put a multiple of that number to come up with a total price. Strong assets or intellectual property make your multiple higher, while the risks associated with the business drive your multiplier down.
How much risk is involved?
Anyone looking to buy your business wants to see that the existing income is likely to continue, and hazards on the horizon will be distinctly off-putting.
Buying into a dwindling industry, for instance, is a risky proposition. Businesses in sunset industries, like video stores and bookshops, are less valuable than those in sunrise industries like niche manufacturing or technology.
Another major risk factor is your client base – are you reliant on just 1 or 2 major clients? The risk inherent in that situation reduces the value of your business.
There are other risk factors, too, says Toresen, including the company’s location, market position, key players, and suppliers.
“If your company has an EBIT of $600,000, and you think it’s a multiple of 4, that’s a value of $2.4 million,” he says. “But if we look at it and find all these issues with it, we might think the multiple’s 3.2 – that drops the value to $1.9 million. That half a million drop will probably upset the owner horrendously.”
How much does it rely on you?
With so many small and micro businesses in New Zealand, sometimes it can be hard to tell if you have a going concern or merely a job for sale. One vital aspect of a small company is whether or not someone else can step in and take over from you.
“How replaceable are you?” Toresen asks. “If your business is about long-standing strong relationships and based on your charisma, that becomes an issue. But if it’s, say, an office-based IT role and anyone could do it, that definitely has value. We sell lots of ‘jobs’, though most have 3 or 4 employees.”
Longevity and potential: not as valuable as you might imagine
It can be hard to view your business objectively when you’ve nurtured it like a baby for many years. The result is that you may see value where none really exists, says Toresen.
Owners of longstanding local service businesses, for instance, may be in for a shock when it comes time to sell.
“Your family business might have been around for 20 years and have a well-known name, but that’s really meaningless,” he says. “You might think you should get a premium, but a new buyer will say there’s not a lot of value in your longevity or reputation if it doesn’t turn a profit.”
Another problem for enthusiastic owners is trying to sell a business on potential. Theoretical plans for growth don’t make your company more valuable, because the new owner is the one who will have to find the funding and carry out all the work.
“This is a trap for people who want to sell hard on future success,” says Toresen. “It’s very tough to sell on potential. We don’t deal with the future; we only deal with the past. The purchaser is the future.”