valuing a business-goodwill

bmwguy

What calculation would you boardsies use to value a business? The net assets part is fine assets less liabilities but what would you use for goodwill. I'm leaning towards about 5 years profit before tax, the businesses I will be looking at will be in the manufacturing sector. All will be going concerns and the products demand will stay strong. They will become part of a wider group, and economies of scale beyond what they can achieve at the moment will occur.

jimmii

5 years seems a good rule of thumb these days though you do see some mad earnings to value ratios though.

Voltex

Has the goodwill value been capitalised onto the balance sheet? If not the value appropriated needs to be verifiable.

barneystinson

Voltex wrote: »

Has the goodwill value been capitalised onto the balance sheet? If not the value appropriated needs to be verifiable.

Huh? The OP is asking about valuing a business, has said they're happy about valuing the net assets (I.e. the bal sheet) and is asking about valuing goodwill, which clearly isn't on the balance sheet... I think you just wanted to use some big words...!

Voltex

barneystinson wrote: »

Huh? The OP is asking about valuing a business, has said they're happy about valuing the net assets (I.e. the bal sheet) and is asking about valuing goodwill, which clearly isn't on the balance sheet... I think you just wanted to use some big words...!

The OP is looking to buy an existing business..or at least that's the way I read it. What big words threw you there? Capitalised, verifiable, balance sheet?

I did also imply that in the absence of a value..one given should still be verifiable (IAS 38).

barneystinson

Voltex wrote: »

The OP is looking to buy an existing business..or at least that's the way I read it. What big words threw you there? Capitalised, verifiable, balance sheet?

I did also imply that in the absence of a value..one given should still be verifiable (IAS 38).

Nothing you said threw me. OP is asking how he should value the goodwill, I read it that he's the prospective purchaser. IAS38 doesn't come into it from that perspective, this isn't an accounting question.

Voltex

barneystinson wrote: »

Nothing you said threw me. OP is asking how he should value the goodwill, I read it that he's the prospective purchaser. IAS38 doesn't come into it from that perspective, this isn't an accounting question.

...and hence the reason people ask questions on forums such as this. Multiple perspectives.
Unfortunately we all suffer the notion of bounded rationality. Asking fairly open ended questions such as the OP's facilitates replies that allow for boundary spanning.

barneystinson

Voltex wrote: »

...and hence the reason people ask questions on forums such as this. Multiple perspectives.
Unfortunately we all suffer the notion of bounded rationality. Asking fairly open ended questions such as the OP's facilitates replies that allow for boundary spanning.

Yep. Words. You didnt, and still haven't, answer the question the OP asked.

Voltex

barneystinson wrote: »

Yep. Words. You didnt, and still haven't, answer the question the OP asked.

How can the Op's question really be answered? Warren Buffet once said “Price is what you pay. Value is what you get.” Without fundamental and technical analysis of the numbers how can someone on here comment on a valuation?

I suggested a direction...what's your contribution?

bmwguy

I was asking for a method of valuation, not an actual valuation. The idea here is that we have a family business and the founder has stated that in 5-8 years time he will be selling it and retiring. In the meantime we will be trying to buy up a few competitors and suppliers (or any viable business really) adding value to them and selling as a group. I dont think I'll be able to retire on it myself, far too young, but I might get a nice cut. Really any businesses bought would need to payback initial investment in this 5 to 8 year timeframe, so current profit times 5 or 6 would be maximum. Hopefully we can add profitability and recoup it quicker, then sell it all. Thanks for the discussion

Peterdalkey

Cant see the logic in this. If all you end up with is investment recovery over the period, where is the financial upside to reward the investment? If you buy at say 5X earnings, I would expect to recover initial investment in less than 3 years by cutting costs and expanding the trading volumes /margins.

Voltex

bmwguy wrote: »

I was asking for a method of valuation, not an actual valuation. The idea here is that we have a family business and the founder has stated that in 5-8 years time he will be selling it and retiring. In the meantime we will be trying to buy up a few competitors and suppliers (or any viable business really) adding value to them and selling as a group. I dont think I'll be able to retire on it myself, far too young, but I might get a nice cut. Really any businesses bought would need to payback initial investment in this 5 to 8 year timeframe, so current profit times 5 or 6 would be maximum. Hopefully we can add profitability and recoup it quicker, then sell it all. Thanks for the discussion

It depends then on the strategy then. The example Iv looked at recently was the Musgraves acquisition of Superquinn.

In 2010 The Musgrave group had booked goodwill in at €120 million. They were turning over €4.3 billion and an EBIT of €75 million. They then bought SQ in 2011 for €228million with fair value on the tangibles being €126 million. The goodwill arising was valued at €102million. Hardly consistent..but the strategy behind the acquisition was clear. Musgraves works off low net margins and requires volume sales and market share to deliver growth.

SBWife

Goodwill is just a consequence of valuation.

I'd value the business as a whole based on a multiple of profits or cash flow, can't give you what multiple I'd use without further information as regards the size of the business, the industry, comparative transaction valuations etc. Once you have the value you are prepared to pay for the business as a whole subtract net assets and you get goodwill.

bmwguy

Peterdalkey wrote: »

Cant see the logic in this. If all you end up with is investment recovery over the period, where is the financial upside to reward the investment? If you buy at say 5X earnings, I would expect to recover initial investment in less than 3 years by cutting costs and expanding the trading volumes /margins.

The logic is by adding value to the business we buy. Almost exactly as you have outlined. The first is a supplier we are looking at, very small but profitable to the tune of 50k on turnover of 300k. I have a figure in my head of paying about 250k for this business but improving their sales/profits through access to our customer base and other factors such as shared bookkeeping/accounts fees. I would hope to make them profitable by 80-100k per year and then when time comes to sell, if the same logic applies it would be worth 400-500k.
Is my thought process sound? I've little experience with this but its fairly exciting all the same.

SBWife

BTW the Net Assets may not be as straightforward as you indicate. As part of a sale transaction the assets would normally be subject to a revaluation, so the values that go onto the acquiring company's balance sheet won't necessarily be at the same valuation that they are currently at in the stand alone business.

bmwguy

SBWife wrote: »

BTW the Net Assets may not be as straightforward as you indicate. As part of a sale transaction the assets would normally be subject to a revaluation, so the values that go onto the acquiring company's balance sheet won't necessarily be at the same valuation that they are currently at in the stand alone business.

The assets are quite small, easy to value. No premises involved in the sale. Stock, plus debtors less creditors. No bank loans. Its the future earnings/payback that will need a bit of calculation. Do we pay on current profit levels or do we factor in the added value we believe that we can bring to the table? I'm thinking we shouldnt pay for this and pay on current situation

SBWife

Valuation is an art not a science. You want to pay enough to get the business but not so much that it won't deliver the a return to you the purchaser. Establish a range based on existing profits and business on the bottom side and the synergies and additional business you can bring on the top side. Aim to be in the bottom portion of the range but paying enough so as to not encourage resentment and negative goodwill among any employees and customers that you expect to bring along with the business. The amount you pay will also be impacted by whether or not there are other bidders for the business and by how motivated the current owners are to sell.

Voltex

SBWife wrote: »

Valuation is an art not a science. You want to pay enough to get the business but not so much that it won't deliver the a return to you the purchaser. Establish a range based on existing profits and business on the bottom side and the synergies and additional business you can bring on the top side. Aim to be in the bottom portion of the range but paying enough so as to not encourage resentment and negative goodwill among any employees and customers that you expect to bring along with the business. The amount you pay will also be impacted by whether or not there are other bidders for the business and by how motivated the current owners are to sell.

So from the Op's perspective he should focus on the incremental cash flows generated from the purchase for his own valuation of goodwill?

The first is a supplier we are looking at, very small but profitable to the tune of 50k on turnover of 300k. I have a figure in my head of paying about 250k for this business but improving their sales/profits through access to our customer base and other factors such as shared bookkeeping/accounts fees

I'm just curious about this bit. If the business you intend to buy is a current supplier to you..how will access to your customers improve the business?

I'm also just wondering would the cash flows in this business cover the cost of financing the purchase without harming future valuations?

Value Hunter

bmwguy wrote: »

The assets are quite small, easy to value. No premises involved in the sale. Stock, plus debtors less creditors. No bank loans. Its the future earnings/payback that will need a bit of calculation. Do we pay on current profit levels or do we factor in the added value we believe that we can bring to the table? I'm thinking we shouldnt pay for this and pay on current situation

A couple of things that cross my mind,

1. Count the full value of the businesses debt, but not the full value of the money their debtors owe them. Use a discount of between 5 - 10% (to cover if debtors default).

i.e if the amount receivable is €50,000, value it at between €45,000 and €47,500.

2. I wouldn't include a valuation on goodwill for such a small company.

If I was too value this business, I would use a simple 'back of a cigarette box' calculation


Net Assets (minus goodwill and discounting account receivables) = x

Net Liabilities = y

Annual Profit = z

Valuation = (X - Y) + 2(Z)*

I would use 3 times annual profit if I believed the probability of growing profit was almost a certainty.


Obviously this formula would only suit certain businesses, it would drastically undervalue a business with low assets but very good profitability, so use your own judgement with regards the type of business you are acquiring.

bmwguy

Voltex wrote: »

So from the Op's perspective he should focus on the incremental cash flows generated from the purchase for his own valuation of goodwill?

I'm just curious about this bit. If the business you intend to buy is a current supplier to you..how will access to your customers improve the business?

I'm also just wondering would the cash flows in this business cover the cost of financing the purchase without harming future valuations?

Our current main company turns over 40 times what the target company does. Their main product is a complementary product to our main product and if owned by us, would be heavily marketed to end users (in favour of alternatives) which doesnt happen at the moment. Sorry for vagueness but just dont want anyone being identified!

SBWife

Voltex wrote: »

So from the Op's perspective he should focus on the incremental cash flows generated from the purchase for his own valuation of goodwill?

He shouldn't focus on the goodwill valuation at all but on valuing the company as a whole. The incremental cash flows should help provide a maximum valuation but naturally the ideal is to pay significantly less than that maximum.

Voltex

bmwguy wrote: »

Our current main company turns over 40 times what the target company does. Their main product is a complementary product to our main product and if owned by us, would be heavily marketed to end users (in favour of alternatives) which doesnt happen at the moment. Sorry for vagueness but just dont want anyone being identified!

Thanks for the reply OP. Just wondering how you would finance this acquisition?
Sounds like you have a pretty good plan and vision for how the business will benefit. Just playing devils advocate here...but vertical integration isn't something id see a lot of these days...more the strategic alliance model. Have you objectively looked at both options?

Peterdalkey

Voltex wrote: »

Thanks for the reply OP. Just wondering how you would finance this acquisition?
Sounds like you have a pretty good plan and vision for how the business will benefit. Just playing devils advocate here...but vertical integration isn't something id see a lot of these days...more the strategic alliance model. Have you objectively looked at both options?

Owner managed/sme businesses and acquisitions are about control not cooperation arrangements, theory and real practice diverge on this one!

Voltex

Peterdalkey wrote: »

Owner managed/sme businesses and acquisitions are about control not cooperation arrangements, theory and real practice diverge on this one!

Dr Gurgiev's review of 2013 Irish M & A data supplied by Experian.

The number of small deals (under €12mln fell by 11.1% on 2012’s figures; down from 54 to 48 transactions. The aggregate value of small transactions also fell - by 26.3%, from €243mln to €179mln

http://trueeconomics.blogspot.ie/2014/01/1412014-irish-m-activity-in-2013.html

Would you say Peter a decision or action that increases the perception of control supersedes a decision that may maximise shareholder value in the mind of a sme owner?

DubTony

I tried to read this thread but couldn't find my dictionary/thesaurus.

:pac:

Peterdalkey

DubTony wrote: »

I tried to read this thread but couldn't find my dictionary/thesaurus.

:pac:

tis always a danger with book-learning!!

barneystinson

Voltex in particular floccinaucinihilipilificates the use of plain English

DubTony

Peterdalkey wrote: »

tis always a danger with book-learning!!

Yeah. I knew I should have gone on and done that MBA. Or even the degree. Or the diploma. Or the leaving cert.

bmwguy

Voltex wrote: »

Thanks for the reply OP. Just wondering how you would finance this acquisition?
Sounds like you have a pretty good plan and vision for how the business will benefit. Just playing devils advocate here...but vertical integration isn't something id see a lot of these days...more the strategic alliance model. Have you objectively looked at both options?

Sorry havent checked in here for a while. Yes we have a fair idea on how to make the business benefit. It will be financed from our reserves or a bank loan, probably reserves,its not a huge figure for us with the relative size differences between the acquiring and target companies

Voltex

DubTony wrote: »

Yeah. I knew I should have gone on and done that MBA. Or even the degree. Or the diploma. Or the leaving cert.

The bigger problem is that the more you "learn" the more aware you become of the volume of what you don't know.

Voltex in particular floccinaucinihilipilificates the use of plain English

I prefer an efficient and effective use of the English language.

smcgiff

Good advice here from SBwife,

Your plan is sound OP, trying to create synergies and make better use of the target's opportunities.

As for how much to pay... It's not unusual for the seller to seek more than what the purchaser should pay (taking everything into account) especially if the seller wasn't considering sale before approach.

Times turnover or profit is a common approach, but you'd want to know a lot more about the target company to be more specific.

Voltex

3 methods Ive seen used to value a business are:

1. Net assets- less intangibles unless independently valued and a careful valuation of current assets (obsolete stock and a provision for bad debts).
2. Historic earnings basis- basically average historical profits x an adj. P/E ratio over the number of ordinary shares in the business.
3. Future earnings basis- which is simply the average future profits x adj. P/E ratio over the number of ordinary shares.

smcgiff

Voltex wrote: »

3 methods Ive seen used to value a business are:

1. Net assets- less intangibles unless independently valued and a careful valuation of current assets (obsolete stock and a provision for bad debts).
2. Historic earnings basis- basically average historical profits x an adj. P/E ratio over the number of ordinary shares in the business.
3. Future earnings basis- which is simply the average future profits x adj. P/E ratio over the number of ordinary shares.

Method 1 is only applicable in a fire sale, and 2 and 3 really only relevant to listed companies.

None of them are likely to be of use to the OP.

Voltex

smcgiff wrote: »

Method 1 is only applicable in a fire sale, and 2 and 3 really only relevant to listed companies.

None of them are likely to be of use to the OP.

Unless your adj encompasses the llc element over listed comparable.

Peterdalkey

plain english?

barneystinson

Voltex wrote: »

The bigger problem is that the more you "learn" the more aware you become of the volume of what you don't know.

I prefer an efficient and effective use of the English language.

OMG are you actually this far up your own .... ?!

It's not very efficient or effective when the other party is left saying, "ummmmm, what did all that jargon mean?!".

barneystinson

Peterdalkey wrote: »

plain english?

He was obviously communicating too efficiently and effectively for you Peter...

Peterdalkey

barneystinson wrote: »

He was obviously communicating too efficiently and effectively for you Peter...

what do you mean?

bmwguy

smcgiff wrote: »

Good advice here from SBwife,

Your plan is sound OP, trying to create synergies and make better use of the target's opportunities.

As for how much to pay... It's not unusual for the seller to seek more than what the purchaser should pay (taking everything into account) especially if the seller wasn't considering sale before approach.

Times turnover or profit is a common approach, but you'd want to know a lot more about the target company to be more specific.

Thanks, I'm kind of new to this but its exciting all the same. I've actually gone back to college to study for CIMA exams which is fairly relevent. Both companies are in manufacturing. Cant really say what industries though , small tight knit industry that would possibly make us very identifiable

Voltex

Peterdalkey wrote: »

plain english?

When comparing apples to oranges you'd want to have a an adjustment factor that allows apples to be different from oranges while at the same time getting a relative answer.

Voltex

barneystinson wrote: »

OMG are you actually this far up your own .... ?!

It's not very efficient or effective when the other party is left saying, "ummmmm, what did all that jargon mean?!".

Apologies if you got confused with jargon somewhere?
Tell me where, and ill try and help you understand it a bit better.

barneystinson

Voltex wrote: »

Apologies if you got confused with jargon somewhere?
Tell me where, and ill try and help you understand it a bit better.

No I'm fine, I don't have a problem interpreting your jibber jabber, but to illustrate my point, Exhibit A:

DubTony wrote: »

I tried to read this thread but couldn't find my dictionary/thesaurus.

:pac:

And Exhibit B:

Peterdalkey wrote: »

tis always a danger with book-learning!!

And Exhibit C:

Peterdalkey wrote: »

plain english?

Voltex

barneystinson wrote: »

No I'm fine, I don't have a problem interpreting your jibber jabber, but to illustrate my point, Exhibit A:

And Exhibit B:


And Exhibit C:

...and your own contribution to this thread is??
Its always easier to complain and moan without offering potential solutions...that's why Joe Duffy is so popular.

Margret Thatcher had a rule where her cabinet colleagues could only inform her of a problem when they had a possible/potential solution to hand...something I have taken and live by.

barneystinson

Voltex wrote: »

...and your own contribution to this thread is??
Its always easier to complain and moan without offering potential solutions...that's why Joe Duffy is so popular.

Margret Thatcher had a rule where her cabinet colleagues could only inform her of a problem when they had a possible/potential solution to hand...something I have taken and live by.

I haven't made a contribution because I think the OP's approach is sound, and there's nothing really to be added to SBwife's sensible and plain English contributions in the first 24hrs of the thread.

I frequently enough deal with/examine the valuation of family run SME's (from a taxes perspective, so quite often there is no actual consideration), and 4-5 times maintainable earnings will probably be a reasonable range.

About the most useful thing you've contributed, in the context of a thread about buying a small company, was the quote from Buffett (no words longer than 5 letters you'll note!).

SeanSouth

This thread is interesting but its not the way it works in practice.

I'm involved in valuing businesses for a living and what we're getting here is the theoretical accounting 101 approach to valuing the business which in my oppinion is not adequate. There is a huge difference between valuing a large business and a small business and you can't value a business while ignoring the market, availability of credit etc etc. A business sold today is worth a lot less than it was in 2006. The valuer needs to know the calculations but also needs to know the market and needs to be able to forecast future cash flows reasonably accurately.

First off, let's have a look at a small family company with total assets of less than 500K. The vast majority of companies in Ireland today are as such.
Small companies are rarely sold complete. What happens in 99% of cases is that the goodwill and fixed assets are sold out from the company and any stocks are then sold at "valuation" The seller is left with the shell of the company including debtors creditors etc which is then wound up separately. It would be foolhardy to purchase a small company outright not knowing what hidden liabilities are hidden within. The next task is to value the goodwill. Multiples of net income will not work here. Some directors / shareholders might pay themselves 20K per year, others 40K and others might pay themselves nothing. These different approaches to remuneration will result in a different net income and could ultimately give rise to an incorrect valuation in inexperienced hands. Its important to realise as well that a business derives value from its expected future cash flows and for that reason when valuing the goodwill of a small business, we use a term called SELLERS DISCRETIONARY CASH FLOW (SDCF) To calculate SDCF, we take PBIT (Profit before interest and tax) and add back any non-cash items such as depreciation. We also add back all owners salary, pension contributions and any other owner benefits. After SDCF is calculated a multiple of between 1-3 is applied. A multiple of 1 is applied where the owner "is the business" and a high risk exists that the business will fall away after the existing owner departs. A multiple of 3 is applied where the risk is minimal. Most valuations today fall in the range of 1.5 to 2.Applying the multiple is where the skill comes in. General business performance past and future needs to be taken into account. Knowledge of the market is important, all risks need to be assessed separately etc etc. And then of course the skill of the negotiator is crucial.

Selling a bigger company is a completely different process. Usually the entire company is sold (the shares are sold) When a company is being sold in its entirety, then the agreement will be much more complex and a careful process of due diligence needs to be undertaken. Larger companies are usually sold on the basis of multiples of PBITDA or price / earnings ratios. Unfortunately, Haven't got time to go into detail now :-) Someone buying a small company is invariably purchasing a job or a lifestyle. Someone purchasing a large company is making an investment. Very very different.

Peterdalkey

Excellent post by SeanSouth. The point about due diligence is an important one as it is expensive and the costs are likely to be far too high relative to the purchase price. However it is the only way to ensure that all the potential latent risks/liabilities are discovered, thus the advice not to buy the shares is spot on.
The valuation methodology is very interesting, pragmatic and useful and very well articulated in plain language,. Well done!

bmwguy

SeanSouth wrote: »

This thread is interesting but its not the way it works in practice.

I'm involved in valuing businesses for a living and what we're getting here is the theoretical accounting 101 approach to valuing the business which in my oppinion is not adequate. There is a huge difference between valuing a large business and a small business and you can't value a business while ignoring the market, availability of credit etc etc. A business sold today is worth a lot less than it was in 2006. The valuer needs to know the calculations but also needs to know the market and needs to be able to forecast future cash flows reasonably accurately.

First off, let's have a look at a small family company with total assets of less than 500K. The vast majority of companies in Ireland today are as such.
Small companies are rarely sold complete. What happens in 99% of cases is that the goodwill and fixed assets are sold out from the company and any stocks are then sold at "valuation" The seller is left with the shell of the company including debtors creditors etc which is then wound up separately. It would be foolhardy to purchase a small company outright not knowing what hidden liabilities are hidden within. The next task is to value the goodwill. Multiples of net income will not work here. Some directors / shareholders might pay themselves 20K per year, others 40K and others might pay themselves nothing. These different approaches to remuneration will result in a different net income and could ultimately give rise to an incorrect valuation in inexperienced hands. Its important to realise as well that a business derives value from its expected future cash flows and for that reason when valuing the goodwill of a small business, we use a term called SELLERS DISCRETIONARY CASH FLOW (SDCF) To calculate SDCF, we take PBIT (Profit before interest and tax) and add back any non-cash items such as depreciation. We also add back all owners salary, pension contributions and any other owner benefits. After SDCF is calculated a multiple of between 1-3 is applied. A multiple of 1 is applied where the owner "is the business" and a high risk exists that the business will fall away after the existing owner departs. A multiple of 3 is applied where the risk is minimal. Most valuations today fall in the range of 1.5 to 2.Applying the multiple is where the skill comes in. General business performance past and future needs to be taken into account. Knowledge of the market is important, all risks need to be assessed separately etc etc. And then of course the skill of the negotiator is crucial.

Selling a bigger company is a completely different process. Usually the entire company is sold (the shares are sold) When a company is being sold in its entirety, then the agreement will be much more complex and a careful process of due diligence needs to be undertaken. Larger companies are usually sold on the basis of multiples of PBITDA or price / earnings ratios. Unfortunately, Haven't got time to go into detail now :-) Someone buying a small company is invariably purchasing a job or a lifestyle. Someone purchasing a large company is making an investment. Very very different.

Hi Sean South, OP here. You have hit on one of my key uncertainties - whether to base price on past (including present) cash flows or on future cash flows taking the value we add into place. I would like to think we can add value, actually I know we can, but base purchase price on historical data. I am of the argument that we should not pay for our own expertise and what we can bring to this business. So plan is, as I think I have said before, to pay 5 times historical PBIT but recoup the investment much quicker than 5 years.

SeanSouth

That's a very interesting question and is really a question of price Vs value.
The price to be paid for a business and its value are two different things.

Buyers will normally only pay a price that relates to current performance and past performance. In extenuating circumstances, a buyer may be willing to pay a premium for future potential but hardly ever.

Value on the other hand is what it is worth to the buyer. When calculating value we will look to see what the business is worth to a new buyer in terms of discounted future cashflows, their ability to develop it and/or synergise it with other businesses. The value in this context should always be greater than the price. Additionally the value to two different buyers may be different.

SeanSouth

BMWGUY - As mentioned above I wouldnt be inclined to price a small business based on a raw 5 X PBIT. You'll have to do a bit more work than that. For example You'll have to take into account what the current owner is paying him or herself out of the business and the accounts will need adjusting for a number of other typical matters. If for example the existing owner is taking a very small salary and getting his wife to work for free at the weekend. its quite possible that you will come to the wrong valuation with 5 X PBIT. You also need to take the industry into account.

Take an example of two identical businesses. Both Businesses have sales of 500K, Gross Profit of 250K Overheads of150K.

One owner awards himself with salary of 70K and his wife works part-time for 20K The other owner awards himself with salary of 20K and his wife works for free.

PBIT in the 1st case is 10K
PBIT in the 2nd case is 80K

The only difference between the 1st business and the 2nd business is that the owner pays himself more in the 1st case. It shouldn't mean that the first business is worth 50K and the 2nd business 400K.

When I hear people talking about valuing small businesses based on multiples of net income, I get very concerned. In most cases its a nonsense. Ive seen accountants do it also. An other contributor earlier in the thread recommended that the value be based on a multiple of turnover !! Yikes.

The reality is that there is no quick and dirty way of valuing a business by multiplying an abstract figure X 5 or X 4 or X 6 unless you really know what you are doing.You really need to go through the accounts forensically to calculate an adjusted profit figure. Another example is where the vendor is using a business premises that is "owned" and for which there is no charge in the accounts.When the business is sold it relocates and the new owner is often faced with paying rent on an alternative premises which immediately impacts the bottom line. This would be a typical adjustment to the accounts before applying the multiple. So the reality is that you will probably use a multiple of some sorts but in all cases the accounts will need adjustments before the multiple is applied. You will also need to know what multiple to use. We tend to use bigger multiples with bigger more stable businesses. Applying a raw multiple to an unadjusted profit figure is like trying to pin the tail on the proverbial donkey with a blindfold on.
The result is often as meaningless as the example given above. One guy will value the business at 50K and the other will value it at 400K and neither of those will be correct. Neither of them will be remotely close.

bmwguy

SeanSouth wrote: »

That's a very interesting question and is really a question of price Vs value.
The price to be paid for a business and its value are two different things.

Buyers will normally only pay a price that relates to current performance and past performance. In extenuating circumstances, a buyer may be willing to pay a premium for future potential but hardly ever.

Value on the other hand is what it is worth to the buyer. When calculating value we will look to see what the business is worth to a new buyer in terms of discounted future cashflows, their ability to develop it and/or synergise it with other businesses. The value in this context should always be greater than the price. Additionally the value to two different buyers may be different.

Yeah we agree there, I want to get a bargain where price is less than value we think it can bring us.

pedroeibar1

bmwguy wrote: »

Yeah we agree there, I want to get a bargain where price is less than value we think it can bring us.

In making that response I think you have missed what SeanSouth is saying. If that is your bottom line you are not going to succeed because you are focussing on a 'bargain' which is the wrong thing. You have to take a realistic long-term view of the acquisition. There have been some interesting posts here but because most are in response to your opening question of ‘valuation’ many replies are academic and quite far from (and ignore) commercial reality.

Valuation on an assets or profits figure or any other basis is meaningless in the overall scheme of things in a small transaction – you must know (as Sean S said) what the acquisition is going to bring to the new entity in the future. It's your industry - only you can know where you can save/make money by using your business model. Do you know what costs you can strip out to change the dynamic? Where? How?

Apart from all of that: - for starters, fact, the seller will choose the transaction type, it’s their call unless they are in a forced sale situation. Will it be an asset sale or share sale? Or a hybrid? A share sale usually means a quicker transaction involving lower costs and involving less extensive/onerous warranties. They might want to retain certain assets along with the possibility of realizing some losses to offset against profits for tax purposes. What are they likely to want? How does that fit with you? Are those assets charged? To whom? Will the charge-holders consent to the transfer?

Part of cost/benefit analysis is the cost of and length of time it will take you to integrate the new business into your existing operation. For example, how long/easy/difficult will it be to integrate the two IT systems? Can the acquisition’s system be easily migrated? (or is it better than yours’? – and don’t believe your IT people!) What is going to happen to your cash-flow? What does your bank have to say? What is customer loyalty like? Importantly, how will your suppliers view the transaction? Will they have to – and more importantly are they prepared - to increase (perhaps substantially?) their credit limits on the new combined entity? Have you considered the position of your key supplier? (In a prior life, a mega-million merger was predicated on our decision – as a key supplier - on our credit/exposure limit.)

Depending on sale method there can be serious disadvantages to the vendors than can be a deal-breaker: extracting sale proceeds usually involves double taxation. On top of that the seller will usually retain liability for pre-completion actions more directly and extensively in a business sale; offsetting that sometimes a higher base cost will be offered in a share sale than in an asset sale. A result is that the seller is left with a ‘shell’ entity which probably will be redundant and will need to be liquidated. Is that a runner? What will be the cost? What will be the market perception? Is there a reputational cost to you as the buyer? (Contagion?)

If it is an asset purchase, the main advantage for you is that you can leave behind assets and liabilities that you don’t want. Excluding the debtors might be attractive to you, but the vendor will have a tough time collecting those outstandings when the business is defunct. Will he agree to that? The approach to an asset purchase is very important if the seller has solvency issues .... if that is the case, the eventual liquidator, and finally the ODCE (if awake) are going to have a view, which the vendor will be aware of. Another advantage is that while employment contracts transfer to the buyer under EU Law, this does not necessarily require the transfer of all pension-related obligations, which can give you some leverage in dealing with the eventual employment costs (pensions issues are critically important in today’s market.)
Have you considered Stamp Duty? it’s payable at 1% on shares and for other assets the rate is generally 6%.

Both buyer and seller must consider the relative benefits of a share sale or an asset sale, and also to consider whether a hybrid would work best, such as a hive down where the seller sells the assets – some of which might be shares - into a different /specially created entity, which you as buyer acquires.

You are entering a minefield, you need professional advice.