Putting a price tag on a business is not an exact science. But you can leave a lot of money on the table if you don't get some advice about what it might be worth.
I'd advise clients to seek valuation advice in the following situations at least:
1. If you are thinking about buying a business;
2. If you are thinking about selling your business;
3. If you have a new shareholder coming on board and need to decide what that new shareholder should pay coming in;
4. If you are restructuring and maybe transferring shares from one entity to another, such as to your Trust;
5. If things have gone bad. This could be where the shareholders are at war and maybe one is wanting to buy the other out;
6. If you and your partner have decided to separate. The shares may often be relationship property.
Why is it important to know in these situations?
Well, because knowledge here does give you some sort of power. And I'm assuming you don't want to leave that money sitting on the table.
Now its easy to see how most of the above situations could lend themselves to disputes. If people can't agree on what the business is worth, we've got a dispute. And a lot of the time, particularly where either a business relationship or a marriage has broken down, and feelings are pretty raw, it can take a lot of effort to achieve a resolution.
I've had times in business disputes where one party has refused to agree with the other just because he can. To spite the other party, even. We are talking about people who came to me three years earlier, when they went into business together, saying they'd been friends since the year dot, and they trusted each other! How things can change.
Once I remember suggesting to a client that he accept a resolution proposed by the former business partner. The resolution wasn't perfect, as I explained to the client. But it was probably as good as it was going to get without the need to still be there, arguing and disagreeing, in two years time, with all the cost, time and stress and anger that goes with that. But because it wasn't exactly what he wanted and because it meant a slight concession to the former childhood buddy, he not only said no, he looked me in the eye and said "are you not looking after my best interests!" You can't help sometimes.
The answers are either put your ego in your pocket and resolve it somehow. Or head off to Court. I try to help people sort it out so it doesn't have to go that far, but if it does we have specialists who love nothing better than to battle it out if thats what you want.
Whatever the situation is, establishing a value for the business can be very important in making the path easier.
We do not value businesses. We would most likely suggest that you have this done by someone specialising in business valuation, such as a chartered accountant with experience in that area.
Typically they will use one of two different methods depending on the reason for the valuation. These methods are:
1. Capitalisation of Earnings
This involves making an assessment of what the future might hold for the business, and applying a multiple. This sort of valuation will usually be relevant to a "going concern" business that is expected to continue. There are three common formulas that you may have heard of for this, namely discounted cash flow, earnings before interest and tax (EBIT), and price earnings ratio (P/E ratio). Each of these effectively comes up with an earnings figure, and a multiple is then applied to that figure to reach a value for the business.
What multiple of earnings is used can depend on a number of factors as well, but basically is a reflection of the risk associated with the business. Some industries typically have higher multiples than others because the earnings are more likely to be sustainable. Others, such as businesses that rely heavily on the personality of one individual, will have a lower multiple because the risk to the buyer is greater.
That is why, if you are thinking of selling your business, systematising everything as much as possible can add value to the business because firstly the valuer will notice this, and secondly it means the business is less reliant on what you as owner carry around "in your head". Either way, don't expect your private company to sell for the type of multiple that a public company's shares might sell for.
2. Net Tangible Assets
If the company is not thriving, or may not even continue as a going concern, then the valuer may value of the business by calculating the Net Tangible Assets of the business. That is, basically what the situation would be if all the assets of the company were to be sold and the debts of the company paid off. The value using this method, will be what is left. Like a liquidation or winding up of the company. No goodwill is factored into it.
Both methods above will involve an assessment of the financial statements and assets of the company, and, particularly with the capitalisation of earnings methods, will also involve a look at what the company expects to achieve in the next period.
There are a whole host of factors that might affect the value and which the valuer will consider. These might include:
1. Are there any one off or extraordinary items that might skew the figures if they are not excluded? Perhaps they show sudden revenue that was not achieved previously and may not be sustainable in the future either. A buyer would want to know that.
2. Do salaries include payments to the owner of the business? Particularly if a client is buying a business we would want to know what sort of remuneration to reasonably expect, based on past performance of the business. If the seller did not work in the business, then the buyer will want to know that. The buyer may see an opportunity to shed some staff and do more work in the business himself. That may also affect what he is prepared to pay for the business.
3. What state are the assets of the business in? Is there a likelihood that items will need to be replaced because the vendor has not invested in the maintenance or replacement of old plant and equipment.
4. What level of debt is the vendor carrying? How much does this affect the bottom line?
5. Are there any assets that are surplus to requirements and could be sold to reduce debt, or deployed to generate income? And should these assets be added to the value of the business on the basis that they can be utilised more effectively?
6. Are any sales trends evident over several years? If so, why? Increased competition? Outdated technology?
7. How does the business compare to other similar businesses, and what those business sold for?
8. Does the business have security of tenure? When does the lease expire? Is location important or can the business operate from anywhere?
Note too that if a minority shareholding only(rather than the whole business)is being sold it will probably sell at a discount. It might have to sell low just to attract a buyer.
At the same time, a "strategic" shareholding might attract a premium. An example of this might be if the buyer already holds some shares, but the new shareholding will give him control of the company.
The situations where you need to know the value of your business are usually highly emotive and you need commercially-focused legal advice or risk coming unstuck. We are experienced in these situations so call me on 03 4500000 or email me at rem@prlaw.co.nz
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