What is a fair price for a business is a difficult question and one that frequently causes doubt and uncertainty. Our advice is frequently requested on whether a price is “fair”. Generally we discuss the following issues with our clients.

 1.            It is worth what you can buy or sell it for 

As simple as it sounds, a business is worth what you can sell it for, or what you can buy it for. The market will normally determine the price for a business. 

Perhaps the best indication of how the market values the business is what other like businesses are being sold or purchased for.   Do some research and try and find out the values of recent sales or similar businesses or those on the market at the moment.

2.            Formal valuations

You can get your business valued by a professional valuer.   Provide the full details of your business and they will give you a valuation or a range of values. If you are finding it difficult to value your business, or if the business is a complex or a large business, consider engaging a valuer. Less formal assistance can be obtained from your accountant or lawyer.

3.            Valuation approaches

There is a range of valuation approaches. These include net asset, future earnings and earnings or profit multiples.

• Earnings or profit multiples

  This method values the business by multiplying the earnings or profit of a business by a variable. It takes into account the goodwill of the business and this together with its wide acceptance and ease of use are its strongest features.   Typically take the earnings before interest and tax and multiply it by a multiple.    The multiple is of course difficult to determine. It tends to be an industry-by-industry proposition.   The key is to try and establish what industry standards are but a multiple anywhere between 3 to 5 for a normal trading business is not unusual although it can be as low as 1 and as high as 10. Where the business is stable, having recurring income, and not dependent on the owner or limited customers, then the multiple should be higher. Regard should also be given to the consistency and trend of profits, and the stage of life of the business (ie: emerging, established, or declining). The multiple used for profit will normally be higher as interest and tax are excluded.
  
  Value = Earnings/before interest and tax and perhaps depreciation x   [Multiple]
  
  Value – Net profit or (After Tax) (NPAT) x [Multiple]

• Net asset valuation

  This simple method relies on adding up the value of the assets and subtracting liabilities.   The problem with this method is it does not include any valuation for goodwill that is central to any business acquisition. Therefore it is generally only for valuing businesses where the holding assets are fundamental, or where the business’ profits are such that there isn’t any goodwill.

  Net asset value = Value of assets minus value of liabilities 

   Future earnings –return on investment
  

• This method works on valuing the potential earnings of the business looking at the rate of return on the investment. Divide the net profit or average net profit of the business by the cost base. The difficulty is determining the appropriate return on investment required. In simple terms, the more risky the investment the higher rate;  the lower the risk the lower the rate.   Returns on investment can vary from 10% for low risk businesses to 20-25% for business with a greater risk profile.  This approach is often used in reverse to determine whether the return on investment is reasonable.
  
  ROI = net profit divided by cost base 

There are numerous other methods to value an investment in a business that may be helpful. These include: Net Present Value (NPV) which essentially values the present value of cash flows from the investment; and Discounted Cash Flow (DCF) which is similar and considers future cash flow projections and discounts them by capital cost.  These are measures more often used for project or investment valuation and are somewhat complex and therefore are not discussed here.

4.            Look at all the factors and discuss it with your advisors.

For a small, medium or emerging business it is difficult, if not impossible to say any one approach is right. We generally consider that the profit or earnings valuation approach is more useful. However, this will depend on the nature of the business and comes with the inherent difficulty of agreeing on a fair multiple.

When looking at the multiple think about a net value of the assets, the growth potential, the client base, and security over key parts of the business such as leases, supply and sales contract. Multiples also depend on growth opportunities, the nature of the business, whether significant capital is required, the net worth or net asset backing.  

We suggest that you look at all the relevant factors and discuss the price with your financial, accounting or legal advisers.

5.            Its different for small business

With smaller businesses the valuation methods may need to be modified.

Profit can be adjusted to take in account owner benefits and interest (presuming that you are not going to take on the debt). This amount is effectively the earnings of the business for the owner. Then apply the multiple which you can adjust taking into account relevant factors. The multiple tends to be a bit lower for smaller businesses in the order of 2 to 4. Where the business is heavily dependent on the owner, such as an owner operator service provider, or strong customer relationships, the multiple is lower. Where the business is more stable having recurring income and not dependent on the owner or limited customers, then the multiple should be higher. Regard should also be given to the consistency and trend of profits, and the stage of life of the business (ie  emerging, established, or declining).