Pricing right

The eternal dilemma for brokers and business owners is finding a fair market value of a business that all parties can agree on. That is probably impossibility, but finding a fair market value that all parties can live with is more achievable.

Drilling down to identify the intangibles (sometimes referred to as goodwill) seems to be the most successful way for us to give comfort to the purchaser and their advisers and financiers. At the same time that shows the owner how their business is affected by market forces and to be able to reasonably manage the value expectations.

It can be like walking a tightrope, but when acceptance is achieved, the sale process is more efficient and pleasant for all parties. Take two manufacturing businesses, each with an annual turnover of $2 million and an EBIT of $500,000, for example, which are located in the same city with identical plant and stock values worth the same. If you looked at the normal methods of business valuation (earnings, comparative or assets) you would have to assume they would be similar at least.

But this really couldn’t be further from the truth. There are so many other factors at play that will affect the risk profile of each of these businesses and, consequently, their value. The most important factor to consider is the sustainability of the income or profits. So really, most factors that you would try to identify would be measured on whether they affect the sustainability of future profits negatively or positively and to what degree.

This probably sounds simple, I know, but it takes work and experience and it means you have to take a position that you feel you can defend.

Take our two manufacturers. What factors could affect the future maintainable profits of these businesses?

1. Cashflow/quality of debtor book: Who are the customers? What are the terms of trade? Do they collect monies owed as agreed?

2. Income risk: Is income contracted? Are margins secure?

3. Working capital requirements: Any stock requirements? Terms of trade from suppliers?

4. Growth prospects: Is the business growing, stable or in decline? Is there anything unique about the business? Does it have new products/services?

5. Competition: Where does this business sit it relation to competitors? Is the business at risk from competitors?

6. Transition: Will the current owner stay on to ensure transition? Are supply agreements assignable? Will staff accept new owners?

7. Barriers to entry: Is there a barrier to entry?

8. Location or lease: Is the location suitable for a current business and for growth? If so is there a good lease available to a new owner?

9. Capital expenditure requirements: Is the plant and equipment current? Are there capex requirements in the business?

10. Concentration risk: Is there a good spread of clients? Does one client make up more than 20% of sales? Is the business at risk to any of its clients?

Obviously there will be more factors to consider when looking at specific businesses, but these provide a good start when setting a capitalisation rate or multiple for your business.