What is your business worth to a buyer?

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Insight into the valuations used to determine a company’s selling price.

The true value of your business is what someone is prepared to pay. Business sellers love an auction process – buyers don’t.

My philosophy and advice when assisting a business owner to sell their business is: don’t take a preconceived price to market – and certainly don’t announce it. This is demonstrated by a recent example of a business for sale which had elicited interest from several potential buyers, including local and offshore businesses.

Local buyers are typically prepared to pay a price based on a four- to five-year pay back on their investment based on achieving economies of scale. In this case, a foreign buyer was looking to make a strategic acquisition to enter the African market and was prepared to accept a 10- or even 15-year payback period. Consequently, they were prepared to pay significantly more than that of the local bidder.

Had we gone to market with a defined bid price such as R100m, that’s what we would have settled on and missed the opportunity to sell for R200m. So, essentially the value of your business is what the right acquirer could achieve with your business post-acquisition. In the above illustration, a foreign company could push new products to new customers through the local business’ channels, unlocking value for their group – on top of what this acquired business was achieving on its own.

Nonetheless, valuations do typically still need to be done by the buyers, and there are two common ways.

The first is a multiple of earnings before interest, taxes, depreciation, and amortisation (Ebitda) which is a metric used to evaluate a company’s operating performance. The second is discounted cash flow, which is a valuation method used to estimate the value of an investment based on its expected future cash flows. Whichever one is used, both come down to the free cashflow and cash generation of the business. If the discounted cashflow methodology is used, a local business would have a much different figure to a foreign buyer. The latter would, for instance, calculate a higher country-risk factor.

Valuations also require a “sense check”. For instance, if it is an asset-heavy business with a lazy balance sheet, a sense check would involve valuing the business by net asset value, whereby one could determine that the profit performance is 80% backed up by assets. In the case of annuity-based software-as-a-service companies, the valuation is typically based on multiples of revenue.

A sense check is necessary because each valuation methodology has pitfalls – each is based on assumptions which may come down to opinion. Frequently, such pitfalls relate to a seller who may have a different view of the value of their own business than do potential buyers – or what it is worth in fact.

For this reason, the structure of the deal is at least as important to de-risk the deal. Structure examples include a seller getting 90% of the purchase price immediately and 10% a year later – or half immediately and the other half in three years’ time. A valuation can also be reinforced by profit guarantees.

Growth without profit, and profit without growth

Other factors can make a business appealing. Timing is key – the motivation for anyone to buy your business is that it is on a growth trajectory. The seller therefore needs to time the disposal so that it has a good history of growth but leaving enough future growth for the buyer. For the buyer, that means the payback period will be quicker and more attractive. If the growth trajectory is already tapering off, then it becomes a more difficult sale as the payback period stretches out.

A potential buyer is looking for a balance of growth combined with profit so that they can grow with the business. If there is either low growth or low profit projected, it becomes a tough sell.

Another area where sellers need to be realistic is in the time frame of a merger and acquisition (M&A) transaction – the entire process is typically a three year one.

For all these reasons, it is important to remove emotion from the process. The best way to accomplish this is by employing the services of a professional. They will understand how the market will view the business, particularly as to where there is value and where there is risk. Therefore, it is a partnership – a professional also cannot work in isolation when going to market.

A valuation must be grounded in market reality, some valuations can be entirely hypothetical, based only on accounting theories. An ear to the ground is always better than textbook valuation theories.

Andrew Bahlmann is the chief executive of the corporate advisory firm Deal Leaders International.

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This article was written exclusively for finweek's 15 October newsletter. You can subscribe to the weekly newsletter here.

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