Determining a business’s value
The key concept when valuing a business is determining the Fair Market Value. This is defined as “the amount at which the business would change hands between a willing buyer and a willing seller when neither is acting under compulsion and both have reasonable knowledge of the relevant facts, and the negotiation for sale is at arm’s length”.
There are several valuation methods commonly used, they are:
- Industry Ratios: Sales record compared with industry averages
- Asset Based: Value of collective assets, tangible and intangible
- Earnings Based: Used for larger businesses; ROI (Return on Investment) and earnings Multiples are common methods
- Market Based: On occasion, none of the above will work. It is not uncommon for the vendor and purchaser to arrive at a value that defies traditional appraisal methodologies but is in keeping with market realities
The main valuation method used in New Zealand is the Earning Based / Multiplier method. This method multiplies the Earnings before Interest, Tax, Depreciation & Amortisation (EBITDA) by a Multiple. The multiple generally ranges from 2 to 4, but can be higher if the business is extremely attractive and is of low risk or there is a strategic buyer prepared to pay a premium.
Most business sales you are buying the assets in the company – “a going concern”, not the shares and therefore you are not taking over the liabilities / balance sheet of the business.
There are two key steps to be taken when determining the value of a business. The 1st is calculation the EBITDA and normalising this and the 2nd is determining the Multiplier.
To normalise the EBITDA we add back any legitimate adjustments with the aim of making the financial statements reflect the actual business earnings and with the goal of increasing the profit as high as possible. All adjustments have to be valid and defendable. Normalisation adjustments will often be adjusting owners salary to reflect the true market salary for the position, adding back personal travel, 1 off consultant fees, business coach, personal entertainment, personal vehicles costs that are not related to the business etc. All these costs will be added back to the EBITDA.
To determine where the multiplier sits in the range a number of thing are taken into consideration – 1. recent sales in the sector and multiples achieved. There is a register called BizStats that has all business sales in NZ by sector and lists the sales, EBITDA, sales price and multiple achieved. The business name is not disclosed. 2. sales myself and my associates at LINK have made in that sector. This analysis will determine a starting or mid-point for the multiplier. Then the starting multiplier is flexed using 8 drivers of value.
The 8 drivers that will influence the multiplier and will all be taken into consideration when determining the value of your business are as follows.
- Barriers to entry – would it be easy for a competitor to become established in this industry? The higher the barrier is the higher the multiple
- Risk profile of the business – does the business rely on 1 or 2 customers, are there supply contracts in place, does the business rely on the owner? The lower the risk profile, the higher the multiple
- Risk profile of the industry – is the industry the business is involved in vulnerable? Is the industry at risk with new technologies i.e. electric cars may reduce the demand for petrol stations & mechanic workshops. Food would be an industry that demand will continue to be strong, thus a higher multiple than the a petrol station or mechanic workshop
- Is the business an established business, a strong brand such as G.J. Gardner Homes – the more established and stable the business, the higher the multiple
- How unique is the business – does the business have a well-defined “niche”, if the business has a point of difference and a well-defined market, product niche the higher the multiple
- Where is the business located – if it is remote or rural, the business generally will be less attractive than a business that is based in a major city which will attract a higher multiple value
- What are the Optics like – is the business attractive, what are buyers first impressions! Does it look attractive, nice offices for customers to visit, good documentation of business practices and health & safety etc. The better the Optics, the more buyers and the higher the multiple
- Size, growth & scalability – larger businesses generally have good management structures in place, have good systems & procedures in place. Therefore are more attractive, and deemed safer to the buyer thus increasing the multiple
The more attractive the business is the greater the buyer demand will be, and the greater the multiple & therefore sales price will be.
For example a kitchen company with an EBITDA of $500k. The NZ BizStats average multiplier for Wooden Joinery – Cabinet Makers is 2.5 x EBITDA giving a valuation of $1.25 million. But we must take into consideration the 8 drivers that flex the multiplier and this could increase it above x 2.5. I recently sold a cabinet making business at a 4 multiplier, almost double the NZ average multiplier. It was an outstanding business with all 8 drivers of value pushing the multiple up and we had multiple offers on the business. This puts the valuation of this example in a range of $1.25 million to $2 million, so you can influence the final sale price of your business by ensuring all 8 drivers are as strong as possible.
If you are thinking about selling, would like some assistance in getting your business ready for sale, help in maximising the sale price of your business or want a business value appraisal – please contact me. All enquiries and discussions will be treated absolutely confidential.
Martin Plom – BBS, CA (Bachelor Business Studies and Chartered Accountant)
LINK Business Broker – Ellerslie, Auckland
P: 09 555 6048 M: 021 051 5507
Martin has had a successful senior executive career in New Zealand and USA, was a business owner for 7 years, (bought and sold with LINK) and joined LINK as a Business Broker. Martin specialises in larger and sometimes more complex businesses and enjoys targeting Strategic buyers.