Are we Buying or Selling?
We are selling and valuing a high volume of businesses right now and this means we are being asked to come up with what a business is worth to many different people. We advise our clients for whom we are selling a business on what we think they can achieve as a reasonable selling price in the marketplace. It may not be worth that to a buyer. That is the age-old dilemma of course, where a seller wants far too much money and a buyer doesn’t want to pay enough. How can this be, when value should be an objective number? Let me demonstrate.
Let’s say that you are the owner of a business that makes $1 million profit per year. That business has made $1 million or thereabouts for the past few years. The future under the current owner looks stable and barring unusual circumstance, that same profit should either continue or grow a little bit. That owner, however, is very important to the business and without that owner being there revenue and profit could suffer. It is not to say they must suffer, however we find that often a change of owner brings its own risk. It’s called the risk of the transaction. A properly educated and informed buyer will look at this business and discount its value accordingly. Where a business normally myself for somewhere in the range of 2 to 3 times its EBIT (Earnings before Interest and Tax), this business may sell for considerably less. The buyer will see this risk and hence reduce their valuation amount accordingly.
Now let us look at it from the seller’s point of view. Assuming that profit will continue into the future, that business would be worth to the owner something well in excess of 3 to 5 times multiple of profit. This is because to get that sort of return on investment anywhere else in the marketplace the vendor would have to spend well in excess of $3 million. If the current business owner invested just $3 million in property, shares, bank deposit or even buying another business (a risky proposition for the same reasons as above) then the return would be anything from $150,000 to maybe $500,000. That same owner may strike it lucky and find another business that would return the profit of $1 million however it would be much safer to stay in the business that you know rather than risk a business that you are not so familiar with.
If the question is “What Is the Business Worth?” The answer might be “Are We Buying or Selling?”