How Does Your Sector Affect Valuing A Business?

Along with marriage, divorce, moving home and death, selling your business is something the majority of people will only ever do once in their lifetimes.

It could be to realise funds to start a new business venture or to allow the continuing trading of a business that is finding itself in troubled times. It could be due to the business finding itself in a stage of stagnation, or perhaps it’s just because you have worked hard and it’s time to cash in on your efforts and enjoy that early retirement. You must, must, get it right, as you won’t be able to get back either your hard earned cash or your company once it’s gone.

For me, the whole “What is my business worth?” and “How has it been valued” question is probably the most important part of this journey you are considering to undertake. For if we get this part wrong from the start, the whole process or journey could be doomed to fail.

Therefore I will now discuss one of the most important things you must consider when valuing a business:

Well meaning business brokerages that do not have experience in the various sectors of business sales will often employ a “smokes and mirrors” attack on naive sellers, promising them huge multipliers (also forgetting to mention “deal structure” throughout the initial discussions) just to get their instructions to sell their business. This normally culminates with them handing the seller a hefty instruction fee for their “expertise” with no promise of success and being tied into a contract of exclusivity that could end in either a lengthy battle to escape from such a clause or a business not selling, which ultimately could be detrimental to the business, your nerves or personal life.

We have found that understanding your sector and how potential buyers value their targets can often lead to sale values of over 400 percent higher the results gained by inexperienced brokers. A great broker will also utilise a number of methods of valuing businesses to not only achieve you a higher return for your hard work, but more importantly to realistically justify this to a potential buyer. Ultimately it doesn’t matter how you package the valuation, it all comes down to one question: “How much cash is going to end up in my pocket?.”

A Senior Broker here at Axis recently had a conversation with a person considering the sale of their business that had just had another meeting with a potential corporate company that specialised in selling SME businesses. They had been told to “never accept any offer that was based on a multiplier of anything less than at least 7 times”. 7 times filed profit? 7 times adjusted profit or EBITDA?

Quickly, we reassured the vendor that this indeed could be right, but as previously stated, before we either confirmed or rejected whether his prior advisor was indeed correct, we probed a bit deeper into his business and sector of trade.

As previously stated, the first point of call made by a good business broker is the sector of work that the potential vendors company trades in. Once we understand this, and a whole raft of other information I shall discuss later, we at Axis would then consider what method to value such a business first. As I will show you, if any business broker is being genuine then they must fully consider this information first before offering any REALISTIC goodwill value, full share value or deal structure to any vendor.

The company my Broker was talking to traded in the Lettings & Estate Agency sector, which we all know since the start of the recession has been affected greatly, with a large number of company owners having to either down size, sell at a reduced sale value or even, I am afraid, fall by the way side.

So let’s assume some figures for the client. Say, a £1 million turnover with £50k filed profits. (Based on a national average of 10% management fee)

So based on his previous advice by the inexperienced corporate broker, they suggested, “Never sell for anything less that at least 6 or 7 times your profits and we would be aiming for nearer 9 times!”

So a bit of quick maths suggests that his “goodwill” value would be in the region of circa £300k to £450k for the sale of his business. Up to 9 years worth of profits, and surely a sign of serious intent from a purchaser as it would mean a return on investment of 9 years!! That’s a long time for a buyer, especially if it’s a venture capitalist backed group pulling the purchasing strings.

Quite rightly, compared to the multipliers of 2, 3 or 4 he had been told from other brokers or his accountant, he was eager to accept such a promise from his potential advisers. But quickly my Broker stepped in a saved him from such an almighty potential error.

Calmly and logically, my Broker explained to the vendor, that this indeed sounded a very good offer, but let’s study the suggestions made by the other corporate broker in a little more detail.

“6 to 9 times”. This consideration for goodwill is based on 6 to 9 times the companies filed profit of £50k, hence a “goodwill” value of £300k to £450k.

So lets consider a common method of how Axis, other Brokers and the vast majority of the accounting and financial world are valuing a business, IE. On the “EBITDA” method. This basically means putting back into the company’s accounts any costs associated with the current owners accessing their cash in the most tax efficient way possible, and also any costs incurred by the current owners due to the way they manage the business etc. This inflates the filed profit figure before Tax and Depreciation up to what we refer to as an “adjusted net profit”.

Typically your accountant would afford you multipliers when valuing with this method of anywhere between 3 to 5 times EBITDA. So in this case, when considering the vendors accounts, it gave an EBITDA of £100k which would suggest goodwill values of between £300k to £500k.

Can you see where this is heading? The vendor could quickly see that by using a “smokes and mirrors” approach, the crafty broker had flashed large multipliers about which on the face of it looked too good to be true, when in fact, they were not too good to be true, but were really in a way, not different than the norm!

But we are not finished here. Again my Broker, using testimony and examples of recent deals completed, explained further still how understanding your company was even more important than this potentially fishy subject of “Multipliers”. You see Axis has been one of the major players in the sale of companies in the corporate sector for over 16 years now, and this is something we pride ourselves in. We have facilitated deals with many of the major “Blue Chip” company’s right down to one man band businesses and from Scotland to Lands End and feel we have the proverbial “finger on the pulse” of such sectors in the current SME market. So did we agree on this method? NO!

You see, understanding the sectors like we do, we explained that in fact the majority of the UK market that specialises in the Lettings & Estate Agency actually values on a method where goodwill is calculated on a multiple of its “Fee income” or to less experienced brokers, “Turnover”.

Both recently and historically, Axis has negotiated sales values for goodwill based on multipliers of up to and over 2 times a company’s fee income. In this case, suggesting our client’s value for goodwill would actually be in the region of circa £2 million pounds and not the previously suggested value of only £300k to £450k! This, on their method, should have equated to multipliers for goodwill of around 40!

After allowing for the client to put his chair right and pick the phone up again, the Broker forwarded over both previous testimonies and current marketing information of similar companies to his that we had recently sold and were currently marketing. Not only to justify our valuation and methods, but to also reassure him of our good intentions to look after him as a client and not just to gain his instruction and hefty consultancy fee, as unlike other corporate business brokers the majority of our fees are performance related, and not upon instruction.

So to summarise, I am not stating that the other methods suggested by other Brokers are wrong or flawed, as saying “ours is the only way!” is not only wrong but arrogant. Being honest, depending on your sector of trade this will and can be a method we use when valuing a business. But I must strongly reiterate the importance of finding a broker that understands your sector or work, your business, and more importantly how the market values and buys businesses in your sector. Any competent brokerage will be able to sell your business, it’s just they will potentially sell if for a sum far, far less that it is potentially worth and that you deserve.

Ian Charlesworth, Senior Valuer

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