Selling Your Business – at What Valuation?
The most common reason why business owners fail to sell their SME business is because they have unrealistic expectations of the value that they will receive. Mark Crossfield of M3 Corporate Finance LLP www.m3cf.co.uk specialises in the sale and purchase of SME business and has experienced all the issues surrounding this.
Crossfield highlights, “The underlying problem is that sellers fail to appreciate the link between valuation and the ability of a buyer to raise the money to fund the purchase.”
The motivation to sell comes from a number of areas, but ultimately any sale transaction will be successful if there is a willing buyer and seller and that the price and structure of the transaction is agreed. As such, the seller must get a feel for the market value and match that with their own expectations. Often these two figures are far apart and the advisors role will be to bring that gap closer through discussion of what is realistic in the market and to a buyer.
Valuation models are well documented and can be quite complicated, however, for the SME the value of the assets and goodwill is the most important. This tends to be reflected in an asset valuation or more commonly a multiple of profits.
Multiples vary depending on sector and size of the business and will vary widely between traditional industries such as manufacturing and say new technology sectors where the latter has potentially got more rapid growth potential. Crossfield goes on to say “It is always dangerous to generalise, but as a rule of thumb, multiples of 3-5 times are regularly seen in the market for business valuations in the £1-10m range, or profits £250-2m range.”
A multiple applies to adjusted sustainable profits, i.e. trading profits averaged back three years and adjusted for owner’s drawings, but inclusive of future owners expected salary where a market rate for the job is typically used. This adds back excessive drawings of profits that are considered irregular from a buyer’s perspective. This has a bearing on the value when the profit figure can be justifiably higher then so does the valuation.
Crossfield also notes the shift in sources of finance for buyers over the last 18 months, “With traditional sources of acquisition funding drying up, this has impacted on the market value of a business as the level of likely funding is a key component of the amount a buyer is willing and able to pay for a business. Apart from asset finance, which is often formula driven, funding for goodwill in a successful business valuation has to come from cash flow lending or equity. Cash flow lending is ‘secured’ on the future cash generation of the business and often is set as a multiple of profits again.
The over rider to this is the ‘debt capacity’ of the business, which will include all debts and their serviceability. We are seeing maximum proposed debt levels at up to twice the cash generation of the business as the ceiling. With equity, the calculation will be similar, although the level of support is linked strongly with the expected future return of the investment (Internal Rate of Return IRR) and the management strength to realise that return.”
It is clear that managing the expectations of buyers and sellers is not a science but an art and more often than not comes back to a will to do a deal.