Is there a "formula" to value a business?
Discussion
Cross post from the Business forum as there may be people on here who can help.
We have an opportunity to "buy" the 60% share of a business from one of the Partners of the company of which my other half is currently an associate.
Is there a basic formula for valueing something like this? We obviously have historical knowledge of turnover and profit over previous years and exact details of current situation re ongoing project and forecasts for the forseeable future.
I understand that there is a goodwill element that cannot be calculated in this way and has to be agreed, but we are struggling to agree on what the value of the available 60% of the business is actually worth.
FWIW the outgoing partner will be leaving the business over a three year period, dropping his days per week over that period and be paid in instalments during that time.
Thanks in advance for any advice.
We have an opportunity to "buy" the 60% share of a business from one of the Partners of the company of which my other half is currently an associate.
Is there a basic formula for valueing something like this? We obviously have historical knowledge of turnover and profit over previous years and exact details of current situation re ongoing project and forecasts for the forseeable future.
I understand that there is a goodwill element that cannot be calculated in this way and has to be agreed, but we are struggling to agree on what the value of the available 60% of the business is actually worth.
FWIW the outgoing partner will be leaving the business over a three year period, dropping his days per week over that period and be paid in instalments during that time.
Thanks in advance for any advice.
There is no cast in stone way of valuing a business, although it does depend on the type of business you are looking at. A business which relies on repeat business and has little by way of assets would be mainly valued in terms of 'goodwill' as you have said (accountants, surveyors, solicitors etc). Depending on the size of the business and how long it has been established you would be looking at 1-3x annual profit (more than that if the business is established with a proven track record).
When I looked at this recently I also considered the payback period - over what time period would you expect a return on your investment which takes account of the extra payment you would recieve (by way of dividends I assume?) If someone is an associate and recieves a salary, I would also expect they would receive dividend in leiu of salary pro rata to each 'day' or portion of equity they purchase - in other words, on purchase of one 'day' a salary of 50k would reduce to 40k but receive a dividend of X instead of the reduced salary. The payback would then equate to the difference between the two values. This has to be considered as anyone buying equity would also have a job to do by the sound of it so the equity cannot be bought by someone who won't be able to do the job full time.
When I looked at this recently I also considered the payback period - over what time period would you expect a return on your investment which takes account of the extra payment you would recieve (by way of dividends I assume?) If someone is an associate and recieves a salary, I would also expect they would receive dividend in leiu of salary pro rata to each 'day' or portion of equity they purchase - in other words, on purchase of one 'day' a salary of 50k would reduce to 40k but receive a dividend of X instead of the reduced salary. The payback would then equate to the difference between the two values. This has to be considered as anyone buying equity would also have a job to do by the sound of it so the equity cannot be bought by someone who won't be able to do the job full time.
z4emsee said:
There is no cast in stone way of valuing a business, although it does depend on the type of business you are looking at. A business which relies on repeat business and has little by way of assets would be mainly valued in terms of 'goodwill' as you have said (accountants, surveyors, solicitors etc). Depending on the size of the business and how long it has been established you would be looking at 1-3x annual profit (more than that if the business is established with a proven track record).
It's an Architectural Practice, so there is an element of repeat business for firms that they have a longstanding relationship with. Most of the jobs are sizeable - so the immediate/mid-term can be accounted for, it's just ensuring that the work remains there, or is replaced in the long term future. They do no Private or Residential stuff, it's all commercial and specialised.z4emsee said:
When I looked at this recently I also considered the payback period - over what time period would you expect a return on your investment which takes account of the extra payment you would recieve (by way of dividends I assume?) If someone is an associate and recieves a salary, I would also expect they would receive dividend in leiu of salary pro rata to each 'day' or portion of equity they purchase - in other words, on purchase of one 'day' a salary of 50k would reduce to 40k but receive a dividend of X instead of the reduced salary. The payback would then equate to the difference between the two values. This has to be considered as anyone buying equity would also have a job to do by the sound of it so the equity cannot be bought by someone who won't be able to do the job full time.
This is a REALLY good point, so thank you.No problem, I've just spent two years working towards equity purchase in a surveying business (also from an Associate position) and there are a lot of things to consider! Good luck with it - if you have any other questions let me know and I'll try and help (although I'm by no means an expert at this!).
I would also recommend sitting down with an experienced and more importantly independent financial advsisor AND accountant. Maybe a solicitor too (revised shareholder agreement etc).
I would also recommend sitting down with an experienced and more importantly independent financial advsisor AND accountant. Maybe a solicitor too (revised shareholder agreement etc).
Simple economics really. Something is only worth what someone is willing to pay.
Whilst there are a number of 'formula' for valuing a business, it's clearly a case tat the seller, and buyer, have to find a mutually agreeable figure, and the way of purchase/release of funds can effect values accordingly.
Having just bought my business partner out in the last month, without any shareholders agreement being in place, and therefore being potentially a nightmare, I would suggest just sitting down & discussing to see whether an agreement can be made.
After each meeting, record 'everything' in writing.
Whilst there are a number of 'formula' for valuing a business, it's clearly a case tat the seller, and buyer, have to find a mutually agreeable figure, and the way of purchase/release of funds can effect values accordingly.
Having just bought my business partner out in the last month, without any shareholders agreement being in place, and therefore being potentially a nightmare, I would suggest just sitting down & discussing to see whether an agreement can be made.
After each meeting, record 'everything' in writing.
As others have said there is no hard / fast rule in business valuation. For small businesses the 1x-3x profit approach is the right sort of ball-park, but likewise you have plenty of publicly listed companies trading at much higher levels (e.g. 10x-20x earnings).
Couple of points you may want to think about to guide you within the very broad range:
1) If the selling partner was instead an employee with an appropriate salary given their experience, how would the accounts of the business look instead - because that is the fairer definition of the underlying profit of the business
2) How much of the profit is wholly dependent on the selling partner and will cease when they leave? Are you actually buying anything of value or a bunch of existing contracts and some trading assets/liabilities?
3) Could you recreate the business by starting up from scratch? How much would that cost?
4) I assume the partner is retiring? If so, what would they be able to do with the equity if they didn't sell to you... do they have realistic alternatives to monetise the equity
5) Have their been any other transfers of equity in the firm's hostory?
In these circumstances deferred payment / phased buyout of equity based on ongoing earnings makes a lot of sense.
Finally, as a suggestion to get some market info you could see whether any accountant friends / contacts are aware of similar businesses in the area having been sold and at what valuation - this is no different to what you find "professionals" doing when they look to value large-cap businesses.
Couple of points you may want to think about to guide you within the very broad range:
1) If the selling partner was instead an employee with an appropriate salary given their experience, how would the accounts of the business look instead - because that is the fairer definition of the underlying profit of the business
2) How much of the profit is wholly dependent on the selling partner and will cease when they leave? Are you actually buying anything of value or a bunch of existing contracts and some trading assets/liabilities?
3) Could you recreate the business by starting up from scratch? How much would that cost?
4) I assume the partner is retiring? If so, what would they be able to do with the equity if they didn't sell to you... do they have realistic alternatives to monetise the equity
5) Have their been any other transfers of equity in the firm's hostory?
In these circumstances deferred payment / phased buyout of equity based on ongoing earnings makes a lot of sense.
Finally, as a suggestion to get some market info you could see whether any accountant friends / contacts are aware of similar businesses in the area having been sold and at what valuation - this is no different to what you find "professionals" doing when they look to value large-cap businesses.
sm1tty said:
1) If the selling partner was instead an employee with an appropriate salary given their experience, how would the accounts of the business look instead - because that is the fairer definition of the underlying profit of the business
'what was your profit last year?'
'100k'
'how much did you pay yourself?'
'nothing'
'what would the profit have been if you'd taken a salary?'
Very useful points already made, and no, there is no simple formula.
You are considering buying (60% of) the assets and liabilities of the business, along with goodwill, which is basically paying for any brand / database / contracts etc that should provide more profit than you or I could earn starting from scratch. You may decide that the combination is valuable to you or not.
Perhaps its also useful to consider the transaction from the seller's perspective:
1. what are their options - do they NEED to sell or want to sell? can they sell later?
2. who owns the other 40% i.e. staff, supplier or unconnected investor - and how does the ownership of the 40% affect the value of the 60%?
3. who else can they sell to?
4. what conditions will other buyers make? e.g. clawback provisions and tie-ins
5. lastly, what are their expectations in terms of value?
You are considering buying (60% of) the assets and liabilities of the business, along with goodwill, which is basically paying for any brand / database / contracts etc that should provide more profit than you or I could earn starting from scratch. You may decide that the combination is valuable to you or not.
Perhaps its also useful to consider the transaction from the seller's perspective:
1. what are their options - do they NEED to sell or want to sell? can they sell later?
2. who owns the other 40% i.e. staff, supplier or unconnected investor - and how does the ownership of the 40% affect the value of the 60%?
3. who else can they sell to?
4. what conditions will other buyers make? e.g. clawback provisions and tie-ins
5. lastly, what are their expectations in terms of value?
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