It’s a question we get asked all the time. To be frank, the question of how to value a business does not have a clear answer – it’s a mix of both art and science. Despite that, this article endeavours to outline some of the considerations business valuers make while plying their craft.
What is the multiple?
Many people understand that most businesses are valued on the basis of a multiple of net profit. Business valuers normally refer to this method of valuation as ‘Capitalisation of Future Maintainable Earnings (FME)’. It’s certainly not the only method of valuation, however it is by far the most accepted in the valuation of small to medium sized enterprises.
So what multiple should you use? Is it 3 or even 4 times net profit? The reality is, there is no golden rule. Across the Australian market place for small to medium sized businesses, sales data suggests that the average multiple is about 2.5 times FME. There are vast differences however between different industries and businesses. This is where non-financial characteristics have a major impact
The Impact of Non-Financial Characteristics
Non-financial information includes (but certainly isn’t limited to):
- Property, plant and equipment leases
- Customer composition and make-up
- Supplier relationships
- Employees and contractors
- External economic factors
- Technology and innovation
Non-financial characteristics have a major impact on the risk profile of an enterprise. Accordingly, non-financial characteristics have a major impact on business values.
Take for example, two businesses, identical in every way, except Business One has a large number of customers in diverse industries, and Business Two only has two customers. Which business is more valuable?
Or, consider two businesses, identical in every way, except Business One has 8 years remaining on its lease term, and Business Two only has 1 year remaining on its lease, meaning they may need to vacate their premises in the short-term. Which business is more valuable?
In both examples, I think everyone would agree that Business One is more valuable. Many other hypothetical examples can be drawn to demonstrate the strong impact of non-financial information on business values.
Market Sales Data
The sale of comparable businesses will also have an impact on accepted business values. Market sales data normally reflects market demand for different industries and business types, and accordingly is useful in assessing the value of a business.
For varying reasons, some businesses are seen as desirable and popular in the marketplace, and others are not. As with all trends, this changes over time.
It is for this reason, that it is important to seek advice from market-savy business valuers who understand how the market is currently reacting to different industries and business types, and what impact this has on values.
Find Out More
If you are seeking a professional advisor to assist you with the merger, acquisition, divestment or valuation of a business with an enterprise value of between $1 million and $50 million please contact Quinn M & A on 02 9223 9166 or email [email protected] to find our nearest office.