Business valuation (what is an appropriate multiplier)
Discussion
A business is worth as much as someone is prepared to pay, no more and no less.
As a guide, for a small-ish business my accountants advice was to take the last three years nett profit (not gross), adjust upwards or downwards to take account of salaries distorted by dividend/pension arrangements (ie reduce nett profits if you only pay yourselves a salary of £6k, increase if you have paid a huge salary to increase pension payments), calculate a weighted mean by adding together 3 times last years adjusted nett plus 2 times the year before plus 1 times the previous year and dividing the total by 6 ((3x2006 + 2*2005 + 2004)/6), then multiplying by a PE ratio of 3 - 5 and adding the asset value to the total.
ie 2006 adjusted nett profits £250k, 2005 nett £200k, 2004 nett £150k), total assets £350k
(((250x3+200*2+150)/6)*3)+350 to (((250x3+200*2+150)/6)*5)+350
or £1000,000 to £1433,333
However, the business is only worth the amount someone is prepared to pay for it.
As a guide, for a small-ish business my accountants advice was to take the last three years nett profit (not gross), adjust upwards or downwards to take account of salaries distorted by dividend/pension arrangements (ie reduce nett profits if you only pay yourselves a salary of £6k, increase if you have paid a huge salary to increase pension payments), calculate a weighted mean by adding together 3 times last years adjusted nett plus 2 times the year before plus 1 times the previous year and dividing the total by 6 ((3x2006 + 2*2005 + 2004)/6), then multiplying by a PE ratio of 3 - 5 and adding the asset value to the total.
ie 2006 adjusted nett profits £250k, 2005 nett £200k, 2004 nett £150k), total assets £350k
(((250x3+200*2+150)/6)*3)+350 to (((250x3+200*2+150)/6)*5)+350
or £1000,000 to £1433,333
However, the business is only worth the amount someone is prepared to pay for it.
thanks david.
i understand it's only worth what someone's prepared to pay, but am just after a guide for valuation. That's a pretty complicated way to work out a value, but have gone through the process & seems to be coming out a little lower than our guess.
it's a tricky area as so many people value in so many different ways. because of our industry we don't have stock & there's little assets in the business, the value lies in skilled employees, clients and business processes that generate a high profit ratio!
thanks for your advice.
i understand it's only worth what someone's prepared to pay, but am just after a guide for valuation. That's a pretty complicated way to work out a value, but have gone through the process & seems to be coming out a little lower than our guess.
it's a tricky area as so many people value in so many different ways. because of our industry we don't have stock & there's little assets in the business, the value lies in skilled employees, clients and business processes that generate a high profit ratio!
thanks for your advice.
There are no hard and fast methods that can be taken as "the" way to value a business.
You can read 100 financial management books on how to do this and come out with 100 different formualae.
There are simply too many variables - and too many unpredictable outcomes. This is because business is absolutely linked to human behaviour. You can use a formula, value a business, buy it - and then find your customers walking away. That type of unpredictable outcome cannot be quantified easily - if at all.
What value a business with a vanishing customer base?
You can read 100 financial management books on how to do this and come out with 100 different formualae.
There are simply too many variables - and too many unpredictable outcomes. This is because business is absolutely linked to human behaviour. You can use a formula, value a business, buy it - and then find your customers walking away. That type of unpredictable outcome cannot be quantified easily - if at all.
What value a business with a vanishing customer base?
Edited by Eric Mc on Friday 29th June 12:37
There are few reconised methods by which HMRC use. Discounted cash flow. Comparable companies (quoted comp's). Comparable transactions.
Discounted cash flow is fairly simple and you'd be better picking that up from wiki or something rather than myself.
Comparable companies is also fairly simple as there are many you can use. They don't need to be the same size, as you calculate the multiple's involved. Try to factor out unusual exceptional items. Obviously there is a Plc premimum which needs removing.
Comparable transactions are also fairly simple. Search for companies that have been sold, and look at what the press said about why it was bought. Quoted companies normally include quite large amounts of info about acquisitions that they make.
Hope its of use.
Discounted cash flow is fairly simple and you'd be better picking that up from wiki or something rather than myself.
Comparable companies is also fairly simple as there are many you can use. They don't need to be the same size, as you calculate the multiple's involved. Try to factor out unusual exceptional items. Obviously there is a Plc premimum which needs removing.
Comparable transactions are also fairly simple. Search for companies that have been sold, and look at what the press said about why it was bought. Quoted companies normally include quite large amounts of info about acquisitions that they make.
Hope its of use.
Eric Mc said:
There are no hard and fast methods that can be taken as "the" way to value a business.
You can read 100 financial management books on how to do this and come out with 100 different formualae.
There are simply too many variables - and too many unpredictable outcomes. This is because business is absolutely linked to human behaviour. You can use a formula, value a business, buy it - and then find your customers walking away. That type of unpredictable outcome cannot be quantified easily - if at all.
What value a business with a vanishing customer base?
Thanks eric, agreed very unpredictable, but really looking for ideas & experience in this specific sector.You can read 100 financial management books on how to do this and come out with 100 different formualae.
There are simply too many variables - and too many unpredictable outcomes. This is because business is absolutely linked to human behaviour. You can use a formula, value a business, buy it - and then find your customers walking away. That type of unpredictable outcome cannot be quantified easily - if at all.
What value a business with a vanishing customer base?
Edited by Eric Mc on Friday 29th June 12:37
LewisTintin said:
There are few reconised methods by which HMRC use. Discounted cash flow. Comparable companies (quoted comp's). Comparable transactions.
Discounted cash flow is fairly simple and you'd be better picking that up from wiki or something rather than myself.
Comparable companies is also fairly simple as there are many you can use. They don't need to be the same size, as you calculate the multiple's involved. Try to factor out unusual exceptional items. Obviously there is a Plc premimum which needs removing.
Comparable transactions are also fairly simple. Search for companies that have been sold, and look at what the press said about why it was bought. Quoted companies normally include quite large amounts of info about acquisitions that they make.
Hope its of use.
http://en.wikipedia.org/wiki/Discounted_cash_flow .... OMG! better dust off my maths text book Discounted cash flow is fairly simple and you'd be better picking that up from wiki or something rather than myself.
Comparable companies is also fairly simple as there are many you can use. They don't need to be the same size, as you calculate the multiple's involved. Try to factor out unusual exceptional items. Obviously there is a Plc premimum which needs removing.
Comparable transactions are also fairly simple. Search for companies that have been sold, and look at what the press said about why it was bought. Quoted companies normally include quite large amounts of info about acquisitions that they make.
Hope its of use.
Edited by cheekymonkey on Friday 29th June 13:38
cheekymonkey said:
Any recommendations of business valuation specialists? I could have a chat with them and get them to suggest based on their experience?
The valuation is completely based on what the valuation is for!Again, an independant valuation is worth exactly what it is - an independant valuation. Thus if this person is neither buying or selling the business this theoretical number is just a theoretical number.
Its a bit like selling property - a 4 bedroom house in Salford is different to Chelsea. A four bedroom detatched is differnt from a semi. Some are larger/smaller, the list goes on...
Business is exactly the same. Of course you do get the estate agent to put a price on it, but whilst a house has an intrinsic value and ballpark resale value because so few people are have the ability of buying a business, then the market is much more let by the demand for the business itself. Of course, this is led entirely on what the *new owners* can make from the business.
Thus it comes down to the nugget of what someone is willing to pay for it.
But, if you want a theoretical figure, be aware that this could change drastically on the basis of an 'assessment' or guess of a factor where a certain performance figure is times by 3, 4, 5, 6, 7, or more!
This 'multiplication factor' has a huge affect on the value and can only be a guess.
Eric Mc said:
srebbe64 here on PH seems to specialise in these matters.
..and gave a very good synopsis in one post which included the cost of replacing the departing owner/operator who is probably living on £5ka year and dividends with a properly paid manager before the calculation begins.JustinP1 said:
cheekymonkey said:
Any recommendations of business valuation specialists? I could have a chat with them and get them to suggest based on their experience?
The valuation is completely based on what the valuation is for!Again, an independant valuation is worth exactly what it is - an independant valuation. Thus if this person is neither buying or selling the business this theoretical number is just a theoretical number.
Its a bit like selling property - a 4 bedroom house in Salford is different to Chelsea. A four bedroom detatched is differnt from a semi. Some are larger/smaller, the list goes on...
Business is exactly the same. Of course you do get the estate agent to put a price on it, but whilst a house has an intrinsic value and ballpark resale value because so few people are have the ability of buying a business, then the market is much more let by the demand for the business itself. Of course, this is led entirely on what the *new owners* can make from the business.
Thus it comes down to the nugget of what someone is willing to pay for it.
But, if you want a theoretical figure, be aware that this could change drastically on the basis of an 'assessment' or guess of a factor where a certain performance figure is times by 3, 4, 5, 6, 7, or more!
This 'multiplication factor' has a huge affect on the value and can only be a guess.
I understand entirely, but consider this an exersize of just getting the estate agent in to give a rough appraisal of a property that's mid rennovation. It gives you an idea that you're heading in the right direction to your ball park sale figure.
Like I said in response to many others i'm just after a guide....a guide that's specific to the industry I outlined.
valuing historic results doesnt guarantee a future value and valuing forward forecasts alone is probably riskier still... having said that id always value forward then validate reliablility of forecasts against a trading history.
valuing forecasted cashflows is probably a good place to start. cash is sposed to be king. multiples are generally fudges used to justify herding around a price point and the creation of an market price mechanism that lazy accountants can use to justify a valuation. (i am a chartered accountant btw...)
if the user of a multiple doesnt like the number they come out with they fiddle with one of the many variables and get a new number.. or if they give up trying to fiddle with variables they just change the multiple itself. whose to say they're wrong?! its often a nonsense comp anyway.
another reason of course people use multiples of revenue is because they cant use multiples of profits as their businesses are loss making!
so id recommend using cashflows. you need to do two calculations: the first looks at forecasts for first 5 or 10 years (if you go that far out... unlikely to be very accurate anyway) and is called a NET PRESENT VALUE (NPV) calculation see link http://www.investopedia.com/terms/d/dcf.asp and second is a Terminal Value (TV) calculation that looks at what happens after you forecast finishes ie out in perpetuity.... clearly this is even less likely to happen! You add the NPV and TV together and bosh theres your value. As a rule, given flakiness of TV calculation i assume a cap at 30% of total value. its as good as any.
anyway. i just joined PH and this is my 1st post. thing is i came on here to look at cars and escape my own startup business, how sad am i
hope the above helps and apologies if i offended any accountants.
valuing forecasted cashflows is probably a good place to start. cash is sposed to be king. multiples are generally fudges used to justify herding around a price point and the creation of an market price mechanism that lazy accountants can use to justify a valuation. (i am a chartered accountant btw...)
if the user of a multiple doesnt like the number they come out with they fiddle with one of the many variables and get a new number.. or if they give up trying to fiddle with variables they just change the multiple itself. whose to say they're wrong?! its often a nonsense comp anyway.
another reason of course people use multiples of revenue is because they cant use multiples of profits as their businesses are loss making!
so id recommend using cashflows. you need to do two calculations: the first looks at forecasts for first 5 or 10 years (if you go that far out... unlikely to be very accurate anyway) and is called a NET PRESENT VALUE (NPV) calculation see link http://www.investopedia.com/terms/d/dcf.asp and second is a Terminal Value (TV) calculation that looks at what happens after you forecast finishes ie out in perpetuity.... clearly this is even less likely to happen! You add the NPV and TV together and bosh theres your value. As a rule, given flakiness of TV calculation i assume a cap at 30% of total value. its as good as any.
anyway. i just joined PH and this is my 1st post. thing is i came on here to look at cars and escape my own startup business, how sad am i
hope the above helps and apologies if i offended any accountants.My company has sold many, many hundreds of companies over the years.
In answer to the question, here are some observations:
Firstly, as previously stated, a company is worth what anyone is prepared to pay for it – so there’s no “correct price”, and three things effect what anyone’s going to pay for it:
1) Return on investment (ie, profit) - Mr Buyer wants his money back!
2) Commercial risk (or perceived risk). High risk = low price and low risk = high price. Which leads nicely onto the issue of “assets”. Assets will effect the value of a company because they can reduce the commercial risk to the buyer (ie, if the whole things goes belly-up you’re at least left with some assets – property, stock, etc..) Such a fact reduces risk and can therefore increase value. Equally, if a company is, for example, reliant on the owner or has one big client, etc..., then clearly this will increase the risk to the buyer – thus reducing value.
3) Bidder competition. If you can locate several buyers and get them bidding against each other then you’ll sell for a great deal more than having just one prospective buyer - market forces will always dictate any company’s value.
Of the above issues, two of them (points 2 & 3) are highly subjective. The third (profit) is far more objective. So if we consider this objective issue, this is typically how a company would be valued by a buyer:
a) Work out the “real” profit of the company by factoring in any replacement costs for the departing owner and work out what the departing owner is ‘really’ taking from the company. As such, you will end up (usually) with an “adjusted" profit figure.
b) Decide what ROI you’re looking for. If you wanted, say, a 20% return (which is typical considering you can get 5% by leaving the dosh in the bank) you would then multiply the adjusted profit by five - and there’s your (ballpark) valuation.
If, however, you’ve done the above calculations and someone is going to outbid you then you’ve got a problem. Equally, if the company has significant growth potential and is low risk then you may be prepared to raise the offer price accordingly. As such, points 2 and 3 come into play. Which brings us round in a nice pretty circle, in that “a company is worth what anyone’s prepared to pay for it”. So I’ve not really been much use – sorry about that!!!
On a related issue, the other thing to bear in mind is that current UK Tax legislation means that you can get 75% Tax (Taper) relief on the capital gain. 75% of 40 (current CGT) is 30 which means the seller will (usually) only pay 10% CGT on the disposal. For example, if a company is making, say, £1m profit and was sold for £5m (5 X EBIT) it would net the owner £4.5m after tax. However, if he chose not to sell but to continue to run the company he’d pay about £300k Corp Tax + Income Tax on + NI, + Emp NI + Tax on Divi, etc.. and probably end up paying about 480k in tax. Also, he couldn’t milk the company for everything because the company will need capital to operate and grow, so he’d probably leave, say £100k in the company. All of which means that of the £1m profit he’ll walk away with probably, say, 380k in his back pocket. Compare this to the £4.5m (post–tax) by selling the company and it’s equivalent to about 13 or 14 years of work. Food for thought.
In answer to the question, here are some observations:
Firstly, as previously stated, a company is worth what anyone is prepared to pay for it – so there’s no “correct price”, and three things effect what anyone’s going to pay for it:
1) Return on investment (ie, profit) - Mr Buyer wants his money back!
2) Commercial risk (or perceived risk). High risk = low price and low risk = high price. Which leads nicely onto the issue of “assets”. Assets will effect the value of a company because they can reduce the commercial risk to the buyer (ie, if the whole things goes belly-up you’re at least left with some assets – property, stock, etc..) Such a fact reduces risk and can therefore increase value. Equally, if a company is, for example, reliant on the owner or has one big client, etc..., then clearly this will increase the risk to the buyer – thus reducing value.
3) Bidder competition. If you can locate several buyers and get them bidding against each other then you’ll sell for a great deal more than having just one prospective buyer - market forces will always dictate any company’s value.
Of the above issues, two of them (points 2 & 3) are highly subjective. The third (profit) is far more objective. So if we consider this objective issue, this is typically how a company would be valued by a buyer:
a) Work out the “real” profit of the company by factoring in any replacement costs for the departing owner and work out what the departing owner is ‘really’ taking from the company. As such, you will end up (usually) with an “adjusted" profit figure.
b) Decide what ROI you’re looking for. If you wanted, say, a 20% return (which is typical considering you can get 5% by leaving the dosh in the bank) you would then multiply the adjusted profit by five - and there’s your (ballpark) valuation.
If, however, you’ve done the above calculations and someone is going to outbid you then you’ve got a problem. Equally, if the company has significant growth potential and is low risk then you may be prepared to raise the offer price accordingly. As such, points 2 and 3 come into play. Which brings us round in a nice pretty circle, in that “a company is worth what anyone’s prepared to pay for it”. So I’ve not really been much use – sorry about that!!!
On a related issue, the other thing to bear in mind is that current UK Tax legislation means that you can get 75% Tax (Taper) relief on the capital gain. 75% of 40 (current CGT) is 30 which means the seller will (usually) only pay 10% CGT on the disposal. For example, if a company is making, say, £1m profit and was sold for £5m (5 X EBIT) it would net the owner £4.5m after tax. However, if he chose not to sell but to continue to run the company he’d pay about £300k Corp Tax + Income Tax on + NI, + Emp NI + Tax on Divi, etc.. and probably end up paying about 480k in tax. Also, he couldn’t milk the company for everything because the company will need capital to operate and grow, so he’d probably leave, say £100k in the company. All of which means that of the £1m profit he’ll walk away with probably, say, 380k in his back pocket. Compare this to the £4.5m (post–tax) by selling the company and it’s equivalent to about 13 or 14 years of work. Food for thought.
srebbe64 said:
My company has sold many, many hundreds of companies over the years.
In answer to the question, here are some observations:
Firstly, as previously stated, a company is worth what anyone is prepared to pay for it – so there’s no “correct price”, and three things effect what anyone’s going to pay for it:
1) Return on investment (ie, profit) - Mr Buyer wants his money back!
2) Commercial risk (or perceived risk). High risk = low price and low risk = high price. Which leads nicely onto the issue of “assets”. Assets will effect the value of a company because they can reduce the commercial risk to the buyer (ie, if the whole things goes belly-up you’re at least left with some assets – property, stock, etc..) Such a fact reduces risk and can therefore increase value. Equally, if a company is, for example, reliant on the owner or has one big client, etc..., then clearly this will increase the risk to the buyer – thus reducing value.
3) Bidder competition. If you can locate several buyers and get them bidding against each other then you’ll sell for a great deal more than having just one prospective buyer - market forces will always dictate any company’s value.
Of the above issues, two of them (points 2 & 3) are highly subjective. The third (profit) is far more objective. So if we consider this objective issue, this is typically how a company would be valued by a buyer:
a) Work out the “real” profit of the company by factoring in any replacement costs for the departing owner and work out what the departing owner is ‘really’ taking from the company. As such, you will end up (usually) with an “adjusted" profit figure.
b) Decide what ROI you’re looking for. If you wanted, say, a 20% return (which is typical considering you can get 5% by leaving the dosh in the bank) you would then multiply the adjusted profit by five - and there’s your (ballpark) valuation.
If, however, you’ve done the above calculations and someone is going to outbid you then you’ve got a problem. Equally, if the company has significant growth potential and is low risk then you may be prepared to raise the offer price accordingly. As such, points 2 and 3 come into play. Which brings us round in a nice pretty circle, in that “a company is worth what anyone’s prepared to pay for it”. So I’ve not really been much use – sorry about that!!!
On a related issue, the other thing to bear in mind is that current UK Tax legislation means that you can get 75% Tax (Taper) relief on the capital gain. 75% of 40 (current CGT) is 30 which means the seller will (usually) only pay 10% CGT on the disposal. For example, if a company is making, say, £1m profit and was sold for £5m (5 X EBIT) it would net the owner £4.5m after tax. However, if he chose not to sell but to continue to run the company he’d pay about £300k Corp Tax + Income Tax on + NI, + Emp NI + Tax on Divi, etc.. and probably end up paying about 480k in tax. Also, he couldn’t milk the company for everything because the company will need capital to operate and grow, so he’d probably leave, say £100k in the company. All of which means that of the £1m profit he’ll walk away with probably, say, 380k in his back pocket. Compare this to the £4.5m (post–tax) by selling the company and it’s equivalent to about 13 or 14 years of work. Food for thought.
I think that is about the most informative and complete answer I have seen to this very common question.In answer to the question, here are some observations:
Firstly, as previously stated, a company is worth what anyone is prepared to pay for it – so there’s no “correct price”, and three things effect what anyone’s going to pay for it:
1) Return on investment (ie, profit) - Mr Buyer wants his money back!
2) Commercial risk (or perceived risk). High risk = low price and low risk = high price. Which leads nicely onto the issue of “assets”. Assets will effect the value of a company because they can reduce the commercial risk to the buyer (ie, if the whole things goes belly-up you’re at least left with some assets – property, stock, etc..) Such a fact reduces risk and can therefore increase value. Equally, if a company is, for example, reliant on the owner or has one big client, etc..., then clearly this will increase the risk to the buyer – thus reducing value.
3) Bidder competition. If you can locate several buyers and get them bidding against each other then you’ll sell for a great deal more than having just one prospective buyer - market forces will always dictate any company’s value.
Of the above issues, two of them (points 2 & 3) are highly subjective. The third (profit) is far more objective. So if we consider this objective issue, this is typically how a company would be valued by a buyer:
a) Work out the “real” profit of the company by factoring in any replacement costs for the departing owner and work out what the departing owner is ‘really’ taking from the company. As such, you will end up (usually) with an “adjusted" profit figure.
b) Decide what ROI you’re looking for. If you wanted, say, a 20% return (which is typical considering you can get 5% by leaving the dosh in the bank) you would then multiply the adjusted profit by five - and there’s your (ballpark) valuation.
If, however, you’ve done the above calculations and someone is going to outbid you then you’ve got a problem. Equally, if the company has significant growth potential and is low risk then you may be prepared to raise the offer price accordingly. As such, points 2 and 3 come into play. Which brings us round in a nice pretty circle, in that “a company is worth what anyone’s prepared to pay for it”. So I’ve not really been much use – sorry about that!!!
On a related issue, the other thing to bear in mind is that current UK Tax legislation means that you can get 75% Tax (Taper) relief on the capital gain. 75% of 40 (current CGT) is 30 which means the seller will (usually) only pay 10% CGT on the disposal. For example, if a company is making, say, £1m profit and was sold for £5m (5 X EBIT) it would net the owner £4.5m after tax. However, if he chose not to sell but to continue to run the company he’d pay about £300k Corp Tax + Income Tax on + NI, + Emp NI + Tax on Divi, etc.. and probably end up paying about 480k in tax. Also, he couldn’t milk the company for everything because the company will need capital to operate and grow, so he’d probably leave, say £100k in the company. All of which means that of the £1m profit he’ll walk away with probably, say, 380k in his back pocket. Compare this to the £4.5m (post–tax) by selling the company and it’s equivalent to about 13 or 14 years of work. Food for thought.
Mods, can you make it a sticky?
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