What's A Business Worth?

The answer to this question is a bit like asking, how long is a piece of string. There are so many variables when valuing a business but ultimately the business is worth what someone will pay.

Before you invest in someone else’s business you need to complete an intensive due diligence process. This includes a detailed analysis of every aspect of the business including the financials, online reputation, the industry trends and the competitors. An impatient buyer who rushes the purchase without doing appropriate due diligence can end up regretting the purchase and pay ‘over the odds’. In some cases, the process may require formal valuations of all the business assets including plant and equipment, vehicles and intellectual property (IP).

The vendor or owner usually sets the asking price and this valuation could be a reflection of their original purchase price, a multiple of future earnings, a percentage of actual revenue or the estimated cost of setting up a similar business from scratch. The vendor is obviously trying to maximise the selling price so it doesn’t always accurately reflect the true value of a business and we often help clients do a valuation or encourage the buyer to seek an independent valuation. A recent survey conducted by CPA Australia found that more than 80% of potential buyers would have paid too much for their  business if they hadn’t carried out proper financial due diligence.

When valuing a business you often need to look at the various components of a business including:

  • Goodwill is basically the reputation, viability and potential of a business. As such, it can be subjective and is independent of the other business components including plant and equipment, fixtures and fittings, debtors, work in progress and inventory. Goodwill should be assessed as part of the overall investment in a business that needs to be sufficiently profitable to at least cover the capital repayments after tax and provide a fair income for the new proprietor.
  • Assets of the business may need to be considered independently and assigned a value. These might include buildings, land, equipment, inventory and fixtures and fittings. Often we look at their written down value (after depreciation allowances) or resale value when attaching a price. If the business for sale is a consultancy type business or in a service industry (medical, architect etc.) the majority of the assets are probably 'intangible assets' like intellectual property and goodwill. In such cases you are selling a client list or database so make sure you keep it up to date.
  • Work In Progress will include any jobs semi-completed and existing contracts the purchaser will inherit.
  • Intellectual Property (IP) is often described as commercial ideas that are generally protected by copyright, patent, design or trademark registration. These can be hard to value and might include things like the business or company name, trade secrets, industrial processes and knowledge banks of information that you have documented.
  • Vendor Liabilities - A buyer may have to take on responsibility for employee entitlements such as holiday and long-service leave. These entitlements would be calculated at settlement and be deducted from the agreed purchase price. The liabilities of the vendor are typically excluded from the sale price and the vendor would normally pay the creditors at settlement. Similarly, a buyer would not take over the debtors of the business at settlement. In some cases, the buyer may take on existing finance arrangements for equipment and this could be another adjustment on sale or the buyer might simply agree to take on the ongoing loan payments. Each case needs to be assessed on its merits.

The process means both the buyer and seller will arrive at their own valuations and then negotiations take place. The valuation can be based on other variables including the general condition of the business and the assets, market supply and demand, the profitability, prevailing economic conditions and cash flow. For businesses costing under $350,000 (excluding stock), a Vendor's Statement (or Section 52 Statement) must also be provided by the vendor to a prospective buyer.

Click HERE to download the full edition of The Business Accelerator Magazine for June 2014.

Other articles in this edition:

IMPORTANT DISCLAIMER:This newsletter is issued as a guide to clients and for their private information. This newsletter does not constitute advice. Clients should not act solely on the basis of the material contained in this newsletter. Items herein are general comments only and do not convey advice per se. Also changes in legislation may occur quickly. We therefore recommend that our formal advice be sought before acting in any of these areas.

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