Advice from Small Business Brokers on Preparing For Sale

Succession or Sale

What’s your Business Worth? Small Business Brokers Give the Low Down

(Also see Business Sale Checklist and Business Sales Process)

By David Meggs

According to research conducted by Professor Kosmas Smyrnios of RMIT University in 2003, 68% of business owners are planning to retire over the next 10 years. This represents an estimated $1.6 trillion (yes trillion) in assets changing hands and management control.

This level of change in business ownership is not surprising, considering that the average age of the owners of businesses with a turnover greater than $1m in Australia is 56 years. However what is surprising is that only 22.7% of owners have a documented succession plan in place to cater for the future of the enterprise.

Selling or providing for the next generations to inherit a business is not an event. It is a process. As small business brokers, we see that few owners will want to pass the business on to a younger family member without some means of securing or withdrawing some or all of the value or equity they have built up in the business. Alternatively, if the business is to be sold, what value can it expect to achieve in the market today, and in the future? Establishing the value of the business is therefore a key component of the process.

The value of a business can vary enormously depending on how well it is managed and how readily it can be taken over by another party without dropping in performance. In short, are systems and processes in place that will ensure the security of the business operations during transition?

A recent example may serve to illustrate the point. (The following is based on a real case, however identities have been protected).

Bill owns and operates a service and parts supply business in Melbourne. After a dozen years or so he was in need of a change. In his mid 50’s he wasn’t entirely sure he wanted to retire but he did want to sell his business. Turnover exceeded $1m and after a moderate salary to him the business showed a moderate net profit.

Following analysis by our small business brokers, the business was valued at between $440k and $480k, including stock. The analysis involved a review of the business, its operations, systems, markets, environment and management culture.

The business was placed in the market for sale and immediately attracted a lot of interest. During the sales process the business broker highlighted various opportunities to improve the business. The intent was to make the business more attractive to the purchaser. Subsequently an offer was made to buy the business at $590k. Negotiations continued for a month or so, extending the total sales process to five months.

At the end of the five month period Bill surprised the intended purchaser by withdrawing the business from sale. The reason? Bill had learned so much during the analysis period, when the broker from P&S had highlighted those issues that could be addressed to improve the business. He had implemented changes immediately with the effect that sales and profits had improved to such an extent that Bill wanted to keep the business.

It was like “running a new company” he said. The value? That had increased by an estimated $250k to $300k. What had made the difference?

Businesses are valued in different ways, but there are only two methods that are used by valuers and appraisers. These are market formula and return on investment.

The market formula approach is generally restricted to specific industries where a formula is applied to income or fees. For example; an accountant may sell his or her practice for anything between $0.55 and $1.00 for each dollar in transferable fees. An equipment hire business may be valued on the basis of 1 to 1.5 times the revenue. In both cases a range is applied. How a specific business is valued within the range will depend upon the type of clients, systems, processes etc.

The return on investment method is by far the most widely adopted means of establishing the value of a business. This involves an approach where the true net profit, which is solely related to the business operations and not to how it is financed or its use as a tax vehicle, is established from the trading accounts. (This is often termed EBITDA or adjusted net profit). This figure is then multiplied by a number (the multiplier) that relates to the value of businesses in a particular industry.

The multiplier is derived from a desired return on investment that a purchaser expects to achieve from the money paid to buy the business. For example; a restaurant with a revised net profit of $200k may demand a return of 40 to 50%. This translates into a multiplier of 2 to 2.5, and a value between $400 and $500k. Whereas a manufacturing business with a similar revised net profit may have an expectation of returning 32% to 42%, with a resultant value range of $475k to $625k.

Larger businesses generally attract lower percentage return expectations and hence higher multipliers. A manufacturing business, with a manager installed, with an EBITDA of $500k may attract a return expectation of 22% to 26%. $1.9m to $2.2m.

Again, note the range in each case. The better the business the higher it will be positioned in the range. Some of the issues that have an effect on the value are:

  • Industry lifecycle: is the business in a growth industry or a declining one?
  • Competition: how strong is the business compared to its competition?
  • Branding: how well known is the business?
  • Supply chain: does the business have strengths when purchasing supplies?
  • Dependence on the owner: will the business operate without the owner?
  • Intellectual Property: trademarks, systems, designs, formulations, etc.
  • Pricing: can a premium price for the goods or services be claimed?
  • Accurate accounts: can the numbers be trusted and accept professional due diligence?
  • Hidden income: saving 30 cents in the dollar tax against a multiplier of three?

The above is a very short but representative list. By subjecting the business to analysis in the early stages and putting a plan into action the prospective retiring owner can expect to achieve much better returns when selling or transferring the business. Perhaps hundreds of thousands of dollars.

For a suggested check list on items to consider when selling your business see our Business Sale Check List.

David Meggs is a Director of P&S Business Brokers Pty Ltd

Call in strictest confidence on (03) 9005 0944