How much is my company worth?

We are often asked, so we are hosting a series of seminars to explain how businesses are valued. For details see our next newsletter, or email [email protected] which will cover valuations in much more detail than we can cover here, and will follow up with a free indicative valuation of your company.

In futures articles we will consider some of the drivers of value, but will start now with how it might be calculated.

This can be very complex, but will typically consider the value of assets and liabilities, as well as a multiple of profit.

Assets and liabilities based valuation

Simplistically this looks at the net asset value of the company in its balance sheet. i.e. the value of all the assets less all of the liabilities. I say simplistically as a few things might need to be adjusted. For example, if you a property in the company, and that property is held at historical cost, you would, assuming property prices have risen since you bought it, be understating the value.

Also with fixed assets you need to be comfortable that they have been maintained. Sometimes sellers might defer repairs and renewals to save money prior to a sale. So, there may need to be a downward adjustment.

There are lots of other things that you would check during due diligence to confirm the value, such as obsolete stock, under provision for bad debts, and contingent liabilities that have not been recorded in the balance sheet. Net assets do though provide a useful start point

Earnings based valuations

Often this is a more important method. In essence, it looks at how those assets in the last methodology are being used to create profits and cash flow to the owners. It is also important for companies that do not create profits from tangible assets. Examples would include solicitors, accountants, and companies that have a database of recurring customers that they sell to.

Earnings based valuations look at profit, and then apply a multiple to that.

You might think that this is a purely mathematical process, but far from it: the least contentious element is profit, but even that can cause disagreement between Accountants. Do you use EBIT -Earnings Before Interest and Tax; Or EBITDA - as for EBIT but also prior to deducting Depreciation and Amortisation. Then there might be disagreement with the overheads that are deducted.

And that is the easy side of the calculation: determining the multiple to apply to the profits is much more of a grey area - more of an art than a science. The multiple might be based, for example, on that used in comparable transactions in the industry, or prior transactions in your own company of they have happened before

EBITDA tends to be commonly used, as with depreciation and amortisation, which are non-cash items, excluded EBITDA acts as a proxy for cash generated by the company. And it is cash that matters to a buyer as that is what they will use to pay a return to themselves, or use to repay debt taken on to purchase the company. I caveat this by saying that capital expenditure also needs to be considered before confirming that EBITDA is the correct one to use.

It is usual to ‘normalise’ EBITDA by considering unusual costs and income. More on that later

A multiple of profit is applied to the normalised EBITDA, which reflects that particular industry, the size of the company and market conditions. To determine this, you would consider the multiple applied to other comparable transactions and that of quoted companies in a similar industry.

The resulting price is an “enterprise value”, from which, any debt (including corporation tax) in the balance sheet is deducted and any “free” or surplus cash added.

This multiple, as you can see, has a huge effect on the overall value that you receive. Let's say your EBITDA is ￡1m, and your buyer has indicated a multiple of 5x to 7x. That ￡2m difference would have a massive impact on your retirement.

Before moving onto the multiple I just want to consider 'normalising' the profit and which period's profit are to be used. 'Normalising' adjustments are required to profit to arrive at a ‘normal’ trading position for the purposes of the valuation. This can include a raft of things such as:

• Directors’ salary adjustments might need to be made reflect more appropriate remuneration levels;
• Payment via dividend not salary;
• Remuneration to family members;
• There could be one off unusual items that are not representative of normal trade

As regards which year you base the profits on, a buyer might want to stick purely to historical profits, based on audited annual accounts. A seller, particularly if profits are rising might want to include a forecast for the year ahead.

What multiple do we use? As mentioned before this is key, but very subjective.

One method is to use comparable transactions in the same industry. Here you research reported transactions in the same or similar markets and determine the multiples pertaining to acquisitions believed to represent a valuation guideline for your company.

In judging whether a reasonable basis for comparison exists you should consider the date of the transaction, the extent to which reliable data is known about the transactions and the reasonableness of the reported multiples. Unfortunately (though understandably) the amounts paid for many privately owned are confidential.

For that reason, it is also useful to consider published data regarding quoted companies to estimate a multiple to be applied to the valuation of privately owned company. The comparison is based on data regarding the public companies’ share price, earnings and market capitalisation.

If the quoted companies are sufficiently similar to each other (industry, operations, market and risk) and your company to permit a meaningful comparison, then it is reasonable to deduce that their multiples should be similar.

An appropriate discount is then applied since as a smaller privately-owned company, shares are not actively traded. Such a discount might be in the order of 65% to 75%.

Free cash

I mentioned earlier that the resulting price is an “enterprise value”, from which, any debt (including corporation tax) in the balance sheet is deducted and any “free” or surplus cash added. Debt includes bank loans, overdrafts, HP, sales factoring, directors’ loans and the corporation tax liability. But what is free cash?

Simplistically it is the amount of cash beyond that which is required for trading activities. One way to think about this is what balance do you feel comfortable with having in the bank account: the amount you need to have to pay suppliers, VAT and PAYE and to leave a contingency. Anything else is therefore 'free' and is added onto the amount you receive.

Conclusion

 Hopefully this has given you an understanding of how companies are valued. If you would like to know more, then join one of our "How much is my business worth?" events. Alternatively call us for a no-obligation discussion.

Ultimately though the true value of your business is what someone will pay you.

If any points in this article strike a chord with you then please contact us. CBSL Accountants' Corporate Finance team have a proven track record of helping companies to acquire and business owners to sell. We help you to identify possible buyers, to understand what those buyers are looking for, and how to present your company to them in a professional way, to maximise the chances of selling your company.

For a confidential discussion, please contact Adrian Barker: [email protected] or to find out about our seminars email [email protected]