How to value your business
It’s the end of the line, time to exit. Or you need investors. Either way, the business you’ve nurtured like an infant has to go on the market. So how do you value your baby?
Hayley Roberts and her partners went through that process in 2011 when they sold a 50% stake in their international recruitment outfit Working In to Waterman Capital. Selling a business is complex, she reckons.
“And it depends on where the purchaser sees value. It could be a trade sale, or a strategic buy. In our case, Watermans is a private equity firm that was looking to invest in a business and we fitted the niche, having an international client base and being scaleable internationally.”
Most businesses are valued using one of three approaches: asset valuation (toting up the assets on the balance sheet); the market approach (earning potential based on theoretical market demand); or income valuation (projecting cashflows, then discounting at some rate) — the latter of which tends to be Kiwi companies’ favoured approach.
In the case of Working In, arriving at a figure involved the tried and trusted method of taking EBITA (earnings before interest, taxes, depreciation, and amortisation) and applying an industry-based multiplier.
Not quite as simple as it sounds, however. Working In has a large online component; arguably it’s also in the media space by virtue of the employment expos it organises; and it is a service company.
“There are a lot of questions on where you place that multiplier. But we did it and had a fair idea [of value] when we went into talks.”
Timing was another factor. Working In — with a history of profitability — had been very highly valued during the boom days, but the sale took place in a recessionary market. “Outside macro factors are in play,” Roberts notes, “and so where people see value in your business, and that multiplier, varies. Someone valuing their business needs to be aware of that.”
Other lessons? “Valuing and selling go hand in hand,” says Roberts. “You need to demonstrate that the buyer will get a return on their investment. What we learned is that it’s important to have all your processes and systems, especially your financial systems and accounts, in tip-top order. You need to be clear and transparent and you need a top accountant; being audited by one of the top-tier firms before you enter the process is fantastic. We had that.”
Nigel Bingham of Pencarrow Private Equity seconds that tip.
The more experienced your professional help the better, he adds. “I’d approach one of the big four — someone who is regularly helping business owners to sell their business. They have a much better feel for the market.”
Bingham confirms that, at least in this country, the standard approach to valuing a business is to take EBITDA, look overseas and locally to find listed companies for a basis for a multiplier, then apply size and liquidity discounts to get some kind of benchmark for an unlisted private company.
But ideally it’s not as cut and dried as choosing one method and sticking rigidly to it; adding secondary techniques or other ratios to the mix can produce more robustness, he says.
How accurate are those multipliers, anyway? “It depends. If the earnings are at a reasonable margin and have been reasonably stable over a period, they can be relatively accurate. If, on the other hand, the business is close to break-even … the numbers can be unreliable. So this is where judgment is important. It’s as much an art as a science, but once you’ve been doing it for a while you do get to know when ratios are reliable or not.”
Pencarrow doesn’t invest in startups, but Bingham reckons valuing them can be an art.
“One technique is to look at the amount of capital put into the firm over a period of time, but that’s not necessarily reliable. Others involve looking at when you expect to become earnings positive and trying to put a multiple on that. Software companies tend to be amenable to a multiple-of-revenue approach.”
For the business owner trying to value their creation, the process can become fogged with emotion. Bingham has seen many owners get into trouble because they refuse to face facts.
“People tend to look backwards to a number they might have been told in a strong economy, and that’s a dangerous thing to do. At the end of the day you have to come up with a number that is going to be reasonable, or you could be on the market for several years.”
For one South Island businessman who doesn’t wish to be named, that’s not a scenario he wants to entertain.
“You have to be realistic about how you go about this. And that’s part of the process of making yourself fit for sale.” A co-owner of a large mainland company founded in the early 1970s, he and his partners are trying to guarantee the business has a long term future after they retire. Going public is one possibility — although not first choice.
His advice on valuing a business? Don’t be greedy. “You need to leave a buck on the table for the next guy, because if you’re too aggressive, you just won’t get people’s interest. So be realistic and really know what your future maintainable earnings are, what the opportunities are, and know that you can back that up by what you’ve done historically.”
History counts. “In fact one of the most important things we’ve learned is that you have to have a story to tell. It has to be credible and one that people can relate to. You need to know that Joe Blow, who has a few hundred thousand dollars in the bank and is looking to invest, can relate to it and understand that story.”