So you run your own business? Do you know what it is worth? How do you value it?
According to data produced by the Australian Small Business and Family Enterprise Ombudsman, there are more than Two Million Small and Medium businesses in Australia. Over 97% of these employ less than 20 people.
61% of these employ no staff, whilst a further 27% employ 1-4 people.
The point of this data? Many of these businesses would not run without the active involvement of the owner. So as a first test of your operating model - could the business operate without you for a sustained period of time?
If not, I call this Self-Employment rather than a Business. Many people are happy being self-employed, others will try and make the migration to a business that deleverages its reliance on the active involvement of the owner.
There are a multitude of approaches and complexities that can go into establishing the value of a business. I won't go too deep here but rather share a selection of the fundamentals.
These include, but are not limited to:
Multiple of Recurring Income or Percentage of Revenue are simple valuation methodologies that are often applied in many scenarios where the real value is in a customer base and the income they generate. We can then apply comparable sales or cash flow modelling, to determine what multiple is applied to the Revenue being acquired.
This method is often applied where a client base is seen as highly portable, and can be readily transferred to an existing business model.
Multiple of Adjusted Earnings before Interest & Taxes ("EBIT") is also a common methodology for established trading business. The Adjusted EBIT is then multiplied to give it a value. Calculating the ‘multiple’ is tricky, and can be industry specific or based on business size.
The first step is in “Normalising” the Earnings to adjust for any items that could be:
- Particular to the current Owner of the business
(e.g. Personal expenses of the Owner included in the P&L).
- Recognising the Owner’s role in the business
(i.e. What would the market salary be to replace the actual time spent in the Business by the owner?).
- Non-recurring Costs or Revenue that is once-off or not continuing.
I see these assumptions missed in so many valuations. For smaller business in particular, Owners often are not properly costed for their time spent performing a functional role in their business.
Consider an example of the following trading business:
| 2018 ($) | 2017 ($) | 2016 ($) | |
| Revenue | 208.4 | 187.9 | 165.0 |
| Gross Profit | 83.4 | 75.1 | 66.0 |
| Expenses | 63.6 | 56.3 | 49.5 |
| Earnings before Interest & Tax | 19.8 | 18.8 | 16.5 |
| Adjustments | |||
| Non-Recurring Income | (2.5) | 0 | (2.0) |
| Adjusted Salary (Owners) | (0.2) | (0.1) | (0.1) |
| Owner Personal Expenses | 0.5 | 0.7 | 0.5 |
| Management Fees | 0.5 | 0.5 | 0.5 |
| Adjusted EBIT | 18.1 | 19.9 | 15.4 |
In this example, the difference between the nominal and adjusted EBIT is not substantial, though there are some potentially adverse trends emerging that would alarm a potential purchaser.
The patterns and consistencies that emerge through different financial years will provide great insights to a potential purchaser. So make sure that you are aware of these too.
Once the Earnings are Normalised, the next step is to determine the Multiple that would apply to these Normalised Earnings.
Generally, in a small business, the multiple used is significantly lower than larger or publicly listed companies. This is because of the reliability or consistency of the Earnings is not as rigorous as a larger business, and typically more reliant on the ongoing contribution of the owner.
The multiple is reflective of the risk around the volatility or certainty of the Earnings moving into the future. The greater the risk, the greater the return I will want which is reflected in a lower multiple being applied. This part takes some experience and at times industry expertise, so you may need some advice.
The multiple is the applied to the Adjusted Earnings above. So, applying a multiple of say 5 times as opposed to 3 times could mean thousands or million of dollars at exit!
I often encounter a scenario where businesses are focused on being "sale ready" when the current owner is right at the end of their tenure. An ideal business should always being ready for sale so you can extract the value out of it both along the way and at exit. They should always know their "multiple".
Lastly, many business owners also talk of their "Goodwill Value".
Goodwill is a premium in valuation commanded beyond Net Assets. Goodwill represents the features of a business that are not usually on a balance sheet (ignoring internally generated goodwill), and are the result of a positive reputation, quality of customer relationships and business history.
If you want to discuss any aspect of your business in the future we would love to hear from you.