Valuations and maximising price when you sell
How do you get the best price for your business when you want to sell?
Take a deep breath before hearing what somebody else – an adviser or purchaser, for instance – thinks your business is worth. You might just be in for a shock.
That’s the fact of the matter. Unfortunately, acquirers don’t always see the blood, sweat and possibly the money you’ve put in to making it successful. Equally, they can’t bank on the potential and growth you believe it promises. They might not even think the business is as unique as you believed it was. And there’s always a chance that you’re not completely au fait with the process of valuing a business.
All of these factors contribute to one universal truth: owner-managers almost always believe their business is worth more than it really is. And while a certain amount of subjectivity has to come into it, the result is that buyers aren’t always prepared to stump up what you would really like.
This doesn’t mean you are necessarily wrong. It means that ultimately you have to accept the price somebody else is prepared to pay – or not sell.
Valuations are key
“The valuation is pretty fundamental,” says Howard Leigh, managing director of Cavendish Corporate Finance. “There’s no point in starting the sale exercise if your perception of value is completely different from that of the market.”
The best way to find out if you’re on the right track is to bring in advisers. Pick two or three accountancy or corporate finance firms, who would like you as their client, and ask them to place a price on the business. This is more of a starting point. Much like selling a house it gives you a ‘ballpark’ figure. It’s then up to you to understand and challenge the valuations. “Your price expectation shouldn’t be a million miles from reality,” says Rob Donaldson, head of M&A and private equity at accountancy firm Baker Tilly.
Despite his firm offering formal valuations (which in some circumstances are useful), he advises potential vendors of businesses not to bother. “It’s not worth spending the money on a formal valuation,” he says. “It’s tens of thousands of pounds wasted. No buyer will look and think ‘that’s alright then’. Having a formal valuation doesn’t guarantee a deal will happen and if it doesn’t you’ve exposed the business.”
He counsels “taking a view on the price and running some numbers”, adding that the price will be what the buyer thinks they can stretch to. It sounds fairly negative, but a big part of selling is being realistic and going to market with a price target that is achievable. “One of the transactions we were involved in was a survivor from the dot com era,” begins Christopher Jenkins, senior partner of accountancy firm Wingrave Yeats, “and having spoken to people during the good times they thought their company was worth twice what it was. We had to bring it down to a sensible figure.”
Advisers can place an approximate price on the company at your first meeting, but they are unlikely to commit formally to it as there are too many variables that could swing it either way. “Good advisers won’t value a business,” says Clive Sanford, chief executive of corporate finance house Magus Partners. “It will give entrepreneurs unrealistic expectations and six months down the road they will remember what you told them. It’s like going down a cul-de-sac and is one of my personal bugbears.”
Donaldson adds that any view on value must take into account other non-financial factors. Critical to that is how ‘sexy’ and how ‘fragile’ the business is. For sexiness, is there something dramatic happening in your market and are you at the forefront? And for fragility, do you depend on one or two key staff or suppliers? Are you particularly reliant on one or two customers? Or are you dependent on something, such as technology, that could soon be out of date? To get a clearer idea, advisers are likely to throw these questions at you.
If you do opt for a formal valuation, it’s likely to take two or three weeks. And there could be some value in making it official if you run a family business, for example, and are selling to other shareholders. “If it’s a trade buyer or a venture capital firm though they’re likely to be very sceptical,” says Donaldson. “Most trade buyers will have an internal team (if a plc) or advisers (if private) who will form their own idea of the value.”
Honesty is the best policy
It’s no wonder you’re positive about your business. But don’t over-egg it. Cavendish’s Leigh is used to dealing with clients who accentuate the positive. “They tend to tell advisers the plus points,” he says, “and forget, or perhaps decide, not to mention any negative aspects, such as the arrival or growth of a major competitor, a key director leaving, or the threat of litigation against you. The more honest you are, the more honest the valuation will be.”
Donaldson adds that potential bidders will often scour the trade press and check the share prices of public companies in their sector, pick the most highly priced deal and use it as a benchmark.
There’s more than one way to skin a cat, and many ways to value a business. Valuations based on earnings are the most common. These are usually calculated as a multiple (called P:E) of earnings (profit after tax). The multiple will be higher for growing companies and where future profits are more reliable. Typically, quoted companies trade at higher multiples than private companies, and a minority stake in a private company is worth considerably less than a majority stake. Very sexy companies, with expectations of considerably higher profits in the future, can sell for multiples in the teens or even higher.
So, for instance, a multiple of four or five might reflect a relatively fragile business that could fade in and out of fashion. Whereas a multiple of 14 or 15 might suggest the company has some significant fixed-term contracts or a great track record. “We sold a magazine publisher at P:E 28, so it can vary wildly,” says Donaldson. “If the buyer thinks they can take a great deal of cost out it will be worthwhile.” Leigh adds that the average business goes for between five and eight post-tax profits.
Lots of deals are done on a debt-free basis, as it allows the buyer to say with certainty that any debts belong to the vendor. This is particularly true of seasonal businesses, which have more debt at a particular time of year. The reason for an acquirer wanting a debt-free deal is certainty, says Donaldson. It is not unheard of for buyers to be unaware of some liabilities at the due diligence stage.
The ‘EBIT (earnings before interest and tax) multiple’ is another option from the same pot. Earnings can be distorted if you have debt in a business, explains Baker Tilly’s Donaldson, and this method takes that into account. Ultimately you would use a lower multiple, but finish with a similar figure, once debts have been accounted for.
If your business is loss-making an ‘asset-based valuation’ may be most appropriate. This involves the purchaser buying physical assets at a premium or discount. Fixed and valuable assets include property, vehicles and fixed term contracts. A premium could be applied if your company possesses valuable intangible assets, such as patents, a ‘unique’ product and sought-after client wins, or intellectual capital, such as key employees.
The ‘discounted cashflow’ method is based on estimated future cashflow. Technology and infrastructure businesses, which have yet to achieve market share, would be most likely to use it. However, while popular during the dot com era, it is used with decreasing frequency now. Similarly, the ‘magic dust’ factor takes into account the market at the time, sentiment towards the sector and feeling about the business, which is entirely subjective.
Finally, there are various other alternatives, based on the industry in question. Valuations may reflect the number and type of contracts or customers you have, properties you own and the square footage involved. The price of Morrisons purchase of Safeway had a lot to do with Morrisons not being able to get the key sites for itself.
The best approach is to try a number of methods and find the middle-ground. To be sure your advisers strive for the highest price though, make sure you offer them incentives on completion rather than a flat fee. Some owners also make arrangements for key members of the management team to be paid a bonus – even if they’re likely to stay with the business – as they may well have to put in a few extra hours to keep performance high, while also playing a part in the deal.
Maximising you valuation
There are ways, both legitimate and otherwise to enhance the valuation of your business. Before you go to market, you need to be sure your company is in the best shape possible for a prospective buyer, so that you achieve the highest price possible.
First up, be clear about what you are selling. If you have fixed assets, such as property or a surplus of cash, which fall outside your method of valuation, you need to pull them out of the equation beforehand. “If buyers buy a business with cash they’ve got to pay for it, unless they’re paying with paper,” explains Leigh. One solution is for you to buy back shares from shareholders. Once you’ve bought back the shares they have to be retracted and cancelled, which enhances the earnings per share and reduces the dividend you have to pay. Remember that what some believe to be ‘surplus’ cash is often actually there to take care of outstanding liabilities. If it is property that is not core to the business, you should consider stripping it out of the business and either selling or redeveloping.
Don’t start believing you can barter for more money to cover the value of assets contained within the business that are essential to it generating the current profits though. “The problem,” says Donaldson, “lies with vendors who agree a price for the business and then want to be paid on top of that for the assets. Those assets in the business are what’s needed to generate the profit each year and are what you’ve just sold on a multiple. Intangible assets fall into that category to a degree. You can get intangible asset valuations done, but typically when a business is sold it all goes into the melting pot.”
‘Grooming’ your business
During the ‘grooming’ process you should take heed of your adviser. They will know what makes a business more attractive.
Generally, put yourself in the buyer’s shoes and eliminate anything that might concern them or leave them unimpressed, including brightening up reception or other areas if they look shabby.
You’d be advised not to try to hoodwink your buyer. But many have tried in the past by changing their accounting policy to inflate profits. “It could have very serious ramifications,” cautions Donaldson. “If you give them a great big reason they’ve got a fantastic opportunity to renegotiate the price down. I think any sensible vendor would be best advised to find legitimate ways to achieve a higher valuation.”
He adds that very few buyers now ‘wing’ the process and that around 85% will commission proper due diligence. Nevertheless, bad deals are still done, but are usually down to poor customer and staff relationships, which due diligence wouldn’t necessarily pick up.
Buyers may also try to renegotiate down if performance levels drop. “The worst thing is when the business underperforms during a sale and takes its eye off the ball. Equally, conditions can change during the course of the deal, including political, legislative and interest rates. These could be dealbreakers,” says Leigh. “What normally happens is they’ll want 10% or so off the price, sometimes for spurious reasons, sometimes for genuine reasons.”
The role of advisers
As well as grooming, advisers are also there to identify the right selection of buyers and to get the ‘auction’ going, leading the negotiations and ultimately closing the deal. While they will try to prepare you for a realistic price, you know your market and business better than them – so if it’s worth challenging, do it.
The price and method of payment is probably the most flexible part of the process and the final stage of the deal. After all, Cavendish’s Leigh says he’s done deals for both 100% paper and 100% cash. Magus Partners’ Sanford is sceptical about taking a significant percentage of paper. “Do you really want to take a risk with somebody else being in control?” he asks.
There are other considerations too, such as what’s going to happen to staff, chemistry and trust between parties, a favourable ‘lock-in’ and ‘non-compete’ agreement and tax planning to maximise your earn-out, which may influence what you accept. Some buyers may issues loan notes (a form of IOU that could help you reduce your tax bill) or facilitate off-shore employment in a tax-free haven for the period of the lock-in. All of these can help bridge the gap between your valuation and the price the buyer is willing to pay. “Basically, no two offers are the same,” concludes Leigh.