To achieve the valuation you are aiming for and to make the business attractive to a buyer could easily take three to five years. So, if you are planning to sell your business in the future, developing an Exit Plan at an early stage can have many benefits.
Having an Exit Plan, which is reviewed annually, can help determine the steps necessary to prepare the business for sale and it can also mean that you are in a position to respond to an unexpected event.
Such events can include an unsolicited approach by a potential buyer, changes in your market sector, new opportunities and health issues in the management team.
Factors which can affect the valuation of a business include the track record of the business, the growth potential of the sector in which the business operates and the strength of the business’s competitive position.
Different approaches to valuing a business include:
- A multiple of earnings: either PBIT (Profit Before Interest and Tax) or EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation)
- A multiple of turnover or a price per user
- Net assets of the business
- Discounted cash flow
- Opportunity cost to the buyer of developing equivalent products and services to your business
A potential buyer may use a combination of these approaches to help them decide the price to offer for a business, but the one most commonly used for SMEs is the multiple of EBITDA.
There are two steps in valuing a business based on a multiple of EBITDA. The first is to establish the underlying earnings and the second is to determine the appropriate multiple.
For the earnings, the starting point is the EBITDA figure from the previous year’s accounts. This figure should then be adjusted so that it represents the typical or normalised EBITDA for the business. The adjustments might include:
- In the case of early stage businesses, Directors often remunerate themselves through a combination of salary and dividends. If this is the case, the Directors salaries should be added back and market salaries for the Directors subtracted. Non-executive Directors fees can also be added back.
- Costs that relate to unusual one-off events can be added back such as professional fees.
- Costs relating to a move of office premises.
- Costs or sales that were accounted for in one financial year but actually occurred across two or more years.
The multiple to be applied to the adjusted EBITDA figure will depend on factors such as the size of the business in turnover terms, the growth prospects for the business, the economics of the sector in which the business operates and the scarcity value of the business. Indications for the appropriate multiple can be obtained from comparable transactions and comparable quoted companies.
For example, a company offering its products as Software as a Service (SAAS) will command a higher multiple than a traditional software licence business model which in turn will typically achieve a higher multiple than a consulting or implementation business. A Printing business might achieve a multiple of 5-6 x compared to a Marketing Services business multiple of 8-10 x. Smaller businesses with good growth prospects in an attractive sector are typically priced at 5 to 8 times whereas businesses in a stagnant sector might only achieve a multiple of 3 to 5 times.
Ultimately, however, a business will sell for what a willing buyer is prepared to offer for the business.
If you are interested in finding out more around how EFM Growth can help guide you through the complexities of selling a business, speak to our team of experienced Growth Partners. Get in touch today through email or call 01582 516300.