Today these 3 methods are the cornerstone of valuing in the SME market:
Extra Earning Potential/Super Profits;
ROI –Return on Investment;
On the one hand, the Seller wants the best possible price for all his hard work in building the business up to where it is today and so he should be able to do. However there is one controlling factor and that is his business is in competition with all other businesses that are up for sale and if your price is not competitive clients will go elsewhere.
On the other side, the Buyer is searching for an opportunity to give him an income that will satisfy his needs and he can build it up further, but at the lowest possible price. However, he is also in competition with other buyers searching for that golden opportunity.
To compound the problem there are over 20 different valuation methods in use and we have all heard that “true value is what a willing buyer is prepared to pay”. Except that the buyer is influenced by his bank, his accountant etc. who have limited experience, so that’s rubbish.
It has always amazed me how everyone is an expert in business valuations and possibly they have been involved in a few transactions in the last year. To create some stability to the whole process sometime ago, a sage said: “If we take the 3 most commonly used valuation methods and average them out, we have Market Value”.
The important aspect of the valuation is that it allows some flexibility for experienced persons in specific industries to input their opinions. This enables the process to be used in virtually every business sector. Explanations:
- EEP/SP: If you invested your money in a bank you would earn R x interest. If you then work in this business as the manager earning a salary you would earn R y. So the total of interest and annual salary would be R x+y. But if you bought the business you would receive the total Ebitda net profit. How much extra is the Ebitda net profit from the business greater than the Rxy you could earn. That amount is the Extra Earning Potential that the business can generate for you.
- ROI: This method estimates the value based on what return a Buyer of the business would expect for the risk of being in a business less a salary.
- Payback: Bases the value on the time period in which you would expect to recoup your investment in.
NB: EBIDTA – Earnings Before Interest Taxation Depreciation Amortisation – includes all the perks an Owner receives from the business.
What is a realistic value for the business?
What is your business worth?
To give you a guide of your business worth complete the information below.
Try it yourself: Insert your own values to value your business.
A few other pointers:
- The Assets are valued at second hand value, not depreciated or replacement value;
- The Stock is the estimated cost value;
- The Interest is bank fixed deposit rate – 6%;
- The Salary is what the business would pay a manager to run the business;
- The Annual Profit includes all the perks the Owner derives from the business;
- The ROI is between .30 and .40 average .35.
The Time Period:
- Service businesses: 9 months to 15 months (low asset base) – Average 1 year
- All other businesses: 18 months (1.5 years) to 30 months (2.5 years)
- Well known franchises may go as high as 36 months (3 years) to 42 months (3.5 years)
Although each of the 3 methods may differ significantly, the average tends to give a Realistic Market Value for the business.