With many businesses being run by ‘Baby Boomers,’ many business owners are nearing retirement and thinking about selling. It’s a buyers’ market.
If you are the seller, obviously you want to get the maximum value for the business and that may be harder than you imagine. Cad Partners suggest you start the process of “grooming” your business for sale well before you put it on the market.
Firstly, CAD Partners financial services franchise recommends that you put yourself in the shoes of a potential buyer. Think about what you would look for if you were buying a business. This is often referred to as ‘Due Diligence’ i.e. the process undertaken to test the value of a business. The method used to value a business is mostly related to the size of the business and the type of industry. For small to medium sized businesses the most common valuation method is a multiple of EBIT (Earnings Before Interest and Tax). That is a business could be worth between one to five times EBIT and the multiple depends on the type of business and risk to future earnings. Other ways that businesses are valued are:
- Discounted Cash Flow – the future net cash flow of the business discounted back to present value at an appropriate discount rate.
- Assets – Going concern value or realisation value – method used where a business is performing poorly and the main value is in equipment and stock.
- Relevant industry (market value or ‘Rule of Thumb’) – a generally accepted multiple of gross income for the industry
- EBIT (Earnings Before Interest and Tax) – multiple affected by a number of factors relating to the nature of the business and its efficiency
- Price to Earnings (P/E) – similar to EBIT Multiple except after tax profit used and a different ratio used for multiple.
- Return on Investment – the return on funds invested to buy the business i.e. net profit before owner’s wages. (Adjustments are made to the net profit)
In the EBIT method profit maximisation is key as well as increasing the multiple in order to get the maximum value for the business.
Ways to increase profit
- Increase the Price of products or services sold
- Sell more volume of products or services
- Reduce the direct cost of products or services (In a product based business – the cost of the item for sale and delivery costs. In a service based business – the cost of delivering the service such as labour and materials)
- Reduce overheads or indirect costs in the business i.e. those costs incurred even if nothing is sold such as rent, wages etc.
The EBIT Multiple is affected by a number of factors such as:
Industry – Is it stable and growing and is it exposed to outside influences or trends?
Business Performance – Profitability, sales, margins, liquidity and control of costs.
Growth – are there opportunities for products/services e.g. geographical expansion. Is the plant and equipment in good condition to capitalise on growth opportunities and are premises capable of handling growth. Is a Business Plan in place and has SWOT (Strengths, Weaknesses, Opportunities and Threats) analysis been performed?
Risk – are costs exposed to interest and currency fluctuation? Is the market depressed or protected by government policy? Are there threats from cheap imports? Is insurance in place? Is new technology a threat? Is secure tenancy in place of premises? Could supplies be disrupted? Could legal claims be made? Is there reliance on a small number of suppliers and do they decide on products/services offered?
Competition – is it aggressive and are there future threats? Is overseas competition likely and can the market sustain the current level of competition? Are the start up costs prohibitive to new competitors and do they need special skills and knowledge?
MIS (Management Information Systems) – are computer accounting and CRM (Customer Relationship Management) systems in place? Does the business report on sales, cost of sales and profit by products/services/employees? Is monthly reporting in place and are operating procedures in place?
Owners – is the business reliant upon the current owner and how easy is it to transfer knowledge – are systems in place? When the current owner departs will key customers and staff be affected? Is there a healthy work/life balance culture in place?
Customers and Market Demand – Is there exposure to big customers and what is the level of customer loyalty? What is the market demand and nature of products/services i.e. are they necessary or discretionary and is there price sensitivity?
Staff – is the industry attractive to staff and how is staff job satisfaction? Are staff experienced and is industry knowledge essential? What HR (Human Resources) procedures are in place – recruitment, retention and motivation? How is staff retention history and how is communication within the business?
Succession – is there Key Person insurance and are there strategies to protect the growth and ability to realise opportunities to increase business value?
As you can see there are quite a few factors that can affect the multiple of EBIT used to value a business, and it’s quite a complicated process to work through. The factors mentioned here are a great starting point to work on, with a view to improving the value of your business. The better these factors operate, the more desirable and valuable your business will be, and a smoother handover to new ownership will be the result.