Part 2: Getting to the highest valuation
The valuation of your company is not a science, but is driven by market forces and your ability to present your business as a significant investment opportunity. To some extent this depends upon the buyer, but it also depends upon the wider economic environment, the state of your own market sector, as well as the state of your business. There are a number of principles that can be applied to valuing your business:
• Earning Multiples – Normally based on historic and possibly forward projections for earnings, measured before depreciation, interest and tax, but adjusted for “average Directors” drawings. The range for this earning multiple can vary from less than 4 to greater than 10 and is dependent on many factors, some of which are mentioned below.
• Net Asset Value – The book value of the company as declared in the balance sheet. In many cases owners may expect to achieve a premium when using this approach to valuation.
• Cash Flow – Normally based on historic and possibly forward projections for cash flow. Debt funders will focus on historic performance, whereas investors may include forward projections, discounted to reflect timings and risk.
Close attention should be paid in the Business Plan to those issues set out below which must be addressed in order to get the business “ready for sale at a premium valuation”.
These are achieved where the business can demonstrate one or more of the following attributes:
• Size – larger businesses attract higher valuations than smaller businesses.
• Strong historical financial performance and projections always attract higher valuations. Remember that every £ invested or spent and not fully recovered in the 2 years prior to selling your company WILL REDUCE the company’s valuation.
• IPR/Technology that is protected by patents, copyright, etc, will enhance the valuation.
• A business operating in a growing market will attract a higher valuation than a similar business in a market that is flat or declining; technology related sectors tend to attract higher valuations
• A blue chip customer base will attract a higher valuation than a similar business that is selling to small to medium sized enterprises.
• A business with a wide spread of loyal repeat customers will attract a higher valuation than a similar business dependent upon a few large customers only or which has to generate new customers continually
• A business with a secure contracted income stream will attract a higher valuation than a business which has to generate its income continually, even if the customers are loyal and regular; the longer the contracted periods, the higher the valuation
• A competent and proven management team will attract a higher valuation than a business which has too high a reliance on exiting owners
• High levels of relevant skills and experience whether technical or process related will attract a higher valuation
• Satisfied and motivated workforce with appropriate lock-in of key staff, via a benefits programme possibly including an Inland Revenue approved share scheme, may not attract a higher valuation, but it will underpin a valuation
• A recognisable brand in its chosen sector, reinforced by a marketing programme which regularly delivers either new customers or new prospects is seen as valuable
• A sales process which relentlessly and consistently mines all leads, enquiries, prospects and customers to generate regular new and repeat business is seen as highly valuable
“Halo” Effect on premium valuations
This is achieved mainly in 3 ways:
• By identifying cost savings synergies usually only available in a Trade Sale,
• By identifying cost savings directly related to the outgoing owner which will not be replaced on the sale to a management team provided the management team are able to finance the acquisition from their own resources or maybe with limited external debt; often the owner (vendor) provides lengthy payment terms to make this possible
• Cross selling products or services, thus reducing the need to win new name customers, again only available in a Trade Sale
• Acquiring technology or know-how which will shorten time to market, again only available in a Trade Sale
In the same way that a Trade Buyer might achieve cost savings, whether one-off or recurring, or benefit from cross selling or technology acquisition, this is unlikely to be the case when selling to your management team or to a buy-in team. The opposite is usually true:
• Costs and / or cash outgoings could rise due to financing costs, corporate governance and repayment burden placed on a management buyer by outside financiers
Other issues that could affect the valuation downwards are:
• Debt repayment required
• Shortage of working capital which will have to be found post acquisition
• Insolvent or very weak balance sheet requiring the injection of additional equity or long term capital
• Weak management requiring the owner to be replaced
• Uncoordinated or unfocused marketing strategy / programme or a weak brand which fail to deliver regular opportunities to sell the company’s products
• Poor sales process with low conversion rates and low new business acquisition
More to follow next time. Please feel free to get in touch with me at email@example.com or on 07904 766230, or for more information, please check out my websites at www.klopartners.co.uk and www.peterkroeger.com
Author – Peter Kroeger