Selling a business
Discussion
I'm not selling one myself... yet, but would like any advice on any generally accepted formula for working out the worth of a business.
As a basic example,
Business (1) carries out pretty consistent projects at say an average price of £3k, and has residual income from existing clients of around £50 per month each. They complete 5 projects per month, lose around 20% of customers per year. By my calculations they will be turning over £180k pa on projects and roughly £19.5k pa on residuals assuming constant uptake of 5 new clients. (I haven't included the 20% loss)
Business (2) does the same as (1), but also tags on smaller projects at a higher volume.
Say £250 per initial customer project, residuals of £25 per month each, and an uptake of 40 customers per month.
Turnover £120k pa on projects, £78k on residuals. (Again not including the 20% loss of customers)
+ the original business of £180k pa + £19.5k residuals
= £300k pa turnover on combined projects + £97.5k on residuals.
In your learned opinions, how much more is model (2) worth than model (1)?
I'm sure there are plenty of factors that can impact the overall worth such as the industry, upsell opportunities etc, but any comments would be gratefully received.
Many thanks for your help!
As a basic example,
Business (1) carries out pretty consistent projects at say an average price of £3k, and has residual income from existing clients of around £50 per month each. They complete 5 projects per month, lose around 20% of customers per year. By my calculations they will be turning over £180k pa on projects and roughly £19.5k pa on residuals assuming constant uptake of 5 new clients. (I haven't included the 20% loss)
Business (2) does the same as (1), but also tags on smaller projects at a higher volume.
Say £250 per initial customer project, residuals of £25 per month each, and an uptake of 40 customers per month.
Turnover £120k pa on projects, £78k on residuals. (Again not including the 20% loss of customers)
+ the original business of £180k pa + £19.5k residuals
= £300k pa turnover on combined projects + £97.5k on residuals.
In your learned opinions, how much more is model (2) worth than model (1)?
I'm sure there are plenty of factors that can impact the overall worth such as the industry, upsell opportunities etc, but any comments would be gratefully received.
Many thanks for your help!
burwoodman said:
In my opinion T/O is meaningless unless are larger company can buy you out and make efficiency gains.
cash is king so all that matters is EBIT. For a small private business with no major capital equipment id take EBIT, deduct an owners salary and multiply by 3 to 3.5
Thanks for your response.
Sorry if I'm being slow, but why deduct owner's salary?
From what you're describing, I'm going to guess it's a close company probably in the building trade?
The problem with valuing a small company like this is that, very often, the true value of the company is invested in the directors/workforce .. and they're the ones selling in order to move on.
Rather than conduct a share sale, if this is the case, it might be better to do an asset sale, including good will. It's a lot simpler and often a lot more accurate. That said ... it can be very disheartening to find what many years of work can actually be worth in black and white.
Might be worth your while going down to a (good) local bookshop and getting something like the LPC guides for accounting and company law - they give, or at least gave, great practical examples that you can just lift from the book and apply to your circumstances.
The problem with valuing a small company like this is that, very often, the true value of the company is invested in the directors/workforce .. and they're the ones selling in order to move on.
Rather than conduct a share sale, if this is the case, it might be better to do an asset sale, including good will. It's a lot simpler and often a lot more accurate. That said ... it can be very disheartening to find what many years of work can actually be worth in black and white.
Might be worth your while going down to a (good) local bookshop and getting something like the LPC guides for accounting and company law - they give, or at least gave, great practical examples that you can just lift from the book and apply to your circumstances.
J1mmyD - thanks for your thoughts.
The model I am looking at would be based around a simple Ltd company in a service market, not in the building trade and very much not dependant on the owner/employees. In fact it could continue to trade just as well with new management, with very low running costs.
I guess what I am looking for advice on is around the reality of what ratio of standard revenues vs. residuals makes for the best multiplier when selling?
i.e. If a business is constantly having to generate new business for larger cost, lower volume products/services rather than low cost, high volume, then is is going to be worth significantly less?
Obviously, with lower cost, higher volume you still have to market yourself efficiently, but it is easier to sell something which is cheaper and effective rather than more expensive and more functional. Plus you still have the opportunity to upsell to your existing client base.
Considering that the target market is SMEs and potentially consumer(a small percentage), how do you get the balance right in order to increase your business's worth?
The model I am looking at would be based around a simple Ltd company in a service market, not in the building trade and very much not dependant on the owner/employees. In fact it could continue to trade just as well with new management, with very low running costs.
I guess what I am looking for advice on is around the reality of what ratio of standard revenues vs. residuals makes for the best multiplier when selling?
i.e. If a business is constantly having to generate new business for larger cost, lower volume products/services rather than low cost, high volume, then is is going to be worth significantly less?
Obviously, with lower cost, higher volume you still have to market yourself efficiently, but it is easier to sell something which is cheaper and effective rather than more expensive and more functional. Plus you still have the opportunity to upsell to your existing client base.
Considering that the target market is SMEs and potentially consumer(a small percentage), how do you get the balance right in order to increase your business's worth?
I buy and sell companies all the time, it’s what I do (about one deal per week.)
Regarding how to value businesses, and the various sales levels you talked about, I think you’re looking at it from a totally wrong perspective. Firstly, 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) Risk (or perceived risk). High risk = low price and low risk = high price.
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 come in to play.
Of the above issues, two of them (points 2 & 3) are highly subjective. The third (point 1) is far more objective. So if we consider this objective issue of “profit”, this is typically how a company would be valued.
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. And a few other bits and bobs. 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 you would then multiply the adjusted profit by five - and there’s your 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”.
Lastly, on a related issue, the other thing to bear in mind is that current Tax legislation means that you can get 75% Tax (Taper) relief on the capital gain. Which, in effect, means the seller will only pay 10% CGT on the disposal. This is particularly relevant for bigger deals. For example, if a company is making, say, £1m profit and was sold for £5m – 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 £300k Corp Tax, + Income Tax on his Salary, + NI, + Emp NI and probably end up paying 500k in tax. Also, he couldn’t milk the company for everything because the company will need capital to operate, 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, 350k in his back pocket. Compare this to the £4.5m post –tax by selling the company and it’s equivalent to about 13 years of work. It makes you think!
Regarding how to value businesses, and the various sales levels you talked about, I think you’re looking at it from a totally wrong perspective. Firstly, 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) Risk (or perceived risk). High risk = low price and low risk = high price.
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 come in to play.
Of the above issues, two of them (points 2 & 3) are highly subjective. The third (point 1) is far more objective. So if we consider this objective issue of “profit”, this is typically how a company would be valued.
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. And a few other bits and bobs. 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 you would then multiply the adjusted profit by five - and there’s your 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”.
Lastly, on a related issue, the other thing to bear in mind is that current Tax legislation means that you can get 75% Tax (Taper) relief on the capital gain. Which, in effect, means the seller will only pay 10% CGT on the disposal. This is particularly relevant for bigger deals. For example, if a company is making, say, £1m profit and was sold for £5m – 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 £300k Corp Tax, + Income Tax on his Salary, + NI, + Emp NI and probably end up paying 500k in tax. Also, he couldn’t milk the company for everything because the company will need capital to operate, 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, 350k in his back pocket. Compare this to the £4.5m post –tax by selling the company and it’s equivalent to about 13 years of work. It makes you think!
srebbe64 thanks for your comprehensive analysis!
I know my example is somewhat oversimplifying things, but you have made some great points there and made me think of things from a different POV.
I'm not actually asking for myself, it is more for me to be able to talk to people I communicate to with work - I need to be able to make some sense when talking about the value of a business and what affects it.
Your answer will be very useful - but I think I need to stop being a tight-wad and buy a book on the subject!
Cheers
I know my example is somewhat oversimplifying things, but you have made some great points there and made me think of things from a different POV.
I'm not actually asking for myself, it is more for me to be able to talk to people I communicate to with work - I need to be able to make some sense when talking about the value of a business and what affects it.
Your answer will be very useful - but I think I need to stop being a tight-wad and buy a book on the subject!
Cheers
[quote=srebbe64]I buy and sell companies all the time, it’s what I do (about one deal per week.)
Sorry to hijack the thread but im considering looking for investment or takeover for my small but rapidly expanding business, maybe with all your experience you could point me in the right direction?
Thx
Sorry to hijack the thread but im considering looking for investment or takeover for my small but rapidly expanding business, maybe with all your experience you could point me in the right direction?
Thx
chocolatemonk said:
[quote=srebbe64]I buy and sell companies all the time, it’s what I do (about one deal per week.)
Sorry to hijack the thread but im considering looking for investment or takeover for my small but rapidly expanding business, maybe with all your experience you could point me in the right direction?
Thx
Feel free to email me via my profile, following which I should be able to give you some pointers.
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