Valuing a business in the UK is not an easy process at all. There are many components to consider within a business.
The typical valuation is based upon the multiples of EBITDA which translates into (Earnings Before Interest, Tax, Depreciation & Amortisation). Then you look at the sector you are buying in, do a quick Google on your sector, punch that EBITDA figure multiply it by what Google told you the multiple was in that sector, and you should receive X amount, walk off into the sunset and go on your private jet to your round the world cruise.
Sorry to burst your bubble, but it is a little bit more complicated than that.
For example, although EBITDA is what the industry takes as a business valuation, if you ask Warren Buffett then he would argue that EBITDA is a flawed valuation model, firstly because when plant machinery or other assets depreciate, if they are essential to how the business makes money, then he would have to replace them and fork out a load of cash should he buy your business, which in turn would depreciate the value of the business, therefore, in Warren’s eye it doesn’t make sense. Let’s be honest, you would want to argue with the success of Mr Buffett.
So, it can be mind boggling but let’s shed light and dig a bit deeper into what we are looking at so we can get some idea.
Spoiler Alert! The bottom line is this, a business is only worth what someone is willing to pay for it. (I know you didn’t really want to hear that, but it is true).
The Balance Sheet
For starters, just take the balance sheet, if you could just look at Profit which is turnover minus expense then this would just be a much simpler issue, but unfortunately it is not. The balance sheet can be quite complicated if you do not know what you are looking for and to the untrained eye it can be like looking into the abyss of confusion.
Interpreting the balance sheet can be tough, so you must look at the business, speak to the professionals and make your own judgement on things.
Example would be to look at the Assets, balance sheets show assets at a historical cost value but not necessarily the true value at the time, for example, if you have property including within the balance sheet, usually property increases in value, whereas the balance sheet will typically show it has depreciated, we all know that that is not a true indication of value.
Intangible Assets – This would be things like Intellectual property, customer base and brand value. If you were selling Adidas or Apple then the intangible assets would hold much more value than the corner shop on the street, maybe the fact that they are the only corner shop within a 5-mile radius would hold this value as a plus point.
Cashflow
A company’s cash flow is the heartbeat of company, a company cannot live if it doesn’t have any cash in the bank because it wouldn’t be able to pay staff, suppliers and wouldn’t be able to function.
A company could have great profits but no cashflow, to give you an example, a company could sell goods and take in orders for up to £1M but not get paid for this for 90 days, they could have to fork out £700k on day one to purchase the stock in order to sell the product making the business have a major cashflow problem if it doesn’t have £700k sitting at any given time to purchase the product first before the nice handsome £300k profitable payday in the days’ time, this is an example of why cash is the lifeblood of a company.
No cash equals no company.
Another point to add is that most business owners think that the cash within the business is theirs to take on a sale. E.g. if you have £300,000 sitting in the business account and you sell the company for £1M, then you would walk away with £1.3M.
Unfortunately, this is not the case, firstly speak to your accountant because at this point in time (2024) you would be taxed on the money as a salary or dividend paying a certain percentage over and above the (currently) £1M business asset disposal relief threshold of 10% of a £1M lifetime business sale relief.
Secondly, the new owners would probably need to input a huge cash injection to pay for your stock, staff, monthly expenses for the business to carry on. Therefore, it is essential to have an amount of working capital within the business for the business to function depending on the business’ expense cycle. This would be for you to work out (maybe with your accountant or a specialist) to see what figure this is.
Are you selling a business or a job?
The definition of a business is ‘a financially profitable enterprise that works without you.’
Taking that definition, if it doesn’t work without you, then you have a job and not a business. That’s ok, but should you sell your job, you must take this into account.
Private Equity firms usually buy a business that has a minimum of a £2M EBITDA and usually they have robust stipulations on any figure that they offer, for example, they may need the seller to stay in the business for a certain period of time (maybe 1-5 years to do the handover) so that figure will be based on you having a job (which you wouldn’t be used to) and a boss to answer to in the form of the private equity company. You may need to earn a certain level of profit before they will give you the figure that has been agreed, so these stipulations could mean more stress in the selling process as opposed to cutting ties and walking into the sunset as we all dream of.
Again, if it is under £2M EBITDA then the buyer will put a value on buying a business with a management structure in place already. A financially profitable enterprise that works without you must mean just that, so there needs to be systems in place and a management team in place alongside the profit to make this easy for a new buyer.
A new buyer who is buying your business for £1M-£2M or more may own multiple businesses and therefore not have time to buy your business on the ‘potential’ that it may or may not bring.
Just like selling a house without planning permission, there are several values it could be post planning and building, but someone must pay for that including the time it takes to make that all happen, you cannot sell it based upon the completed price of somebody else’s works.
Therefore, your company’s potential doesn’t always cut it.
If there is a management team already in place or can be promoted from within, then this holds so much more value for a buyer as the buyer doesn’t really have to get involved with the day to day operations of the business and he or she can be more of a consultant, advisor and sit on the board having meetings once a week or can go out and be the business’s development manager and trying to create new sales, as opposed to handling the operations, dealing with the staff, the finances and/or dealing with the bank managers and trying to get funding for the business.
Having a good management team in place means that the buyer can then move onto creating wealth as opposed to solving problems and bottlenecks that somebody else can sort out.
Systems, SOPs, Efficiencies, Automation
If I walked into your company today, what would I see? If I took ownership over your company today, how would it be? Would it be seamless, or would it be messy? Are you covering up problems and issues or does the future look smooth?
I know that there are minor issues in everyone’s companies such as that member of the team who has gone off the boil or needs to be managed out. That difficult customer who is a category D rated customer that shouldn’t really be there in the first place but gives you a decent amount of business. But how does it flow and operate?
How are your systems documented? Are they written down in a manual, are they in video format? Are there good instructions in place for new team members? What does your compliance say? Is there a good induction process for new team members?
What are your standard operating procedures? Just like the functionality of a car, a car cannot drive if the engine doesn’t work, or the steering wheel isn’t there and a car must have petrol also (you could probably relate this to cashflow), without petrol you won’t get very far.
The business gurus also speak about beginning with the end in mind, I do sometimes struggle with this and have never done anything with the end in mind, but I do get it. I would change that slightly when it relates to a company and say: ‘even if you are not ready to sell your business, if someone came into your business today and gave you an offer you couldn’t refuse, would they regret it? Is your business in a saleable state? You never know when it is time to sell your business.
How does it flow?
Debt
Dealing with Debt and settlement with business acquisitions can be tricky, but not impossible. Some buyers will want all the debts cleared off; other buyers will be willing to take on your debt to facilitate a sale because it would mean less money down from their pocket.
Banks get a bad name, but debt is an economic invention that allows our economy to grow and has leveraged many businesses and created our social and economic system in many countries.
Everything in moderation: Too much debt is bad, but too little debt usually means you are uneducated, unless you want to leave the shackles of western life & be debt free living on an island in the middle of nowhere without a smart phone (It’s an option that I won’t go into today)
When a buyer buys your business, becomes the Director, they take on the liability of the Director and therefore, the debt.
If you owe HMRC VAT money or Corporation tax, this should be accounted for in the balance sheet and is a debt that the new owner must pay, the bill needs to be settled by someone.
With an Asset Purchase, it is much simpler to acquire because you are stripping something that has value out of the business as opposed to buying the company as a hole, again, doing this has tax implications and it is a bit more complicated than just forgetting the debt, there is a process.
You can sell your business with the debts; you can do a deal to pay off the debts as the seller. You can decide to split or share a portion of the debt in play, and it all does depend on the deal structure in play when you sell the business.
The Earn Out
The Earn Out method is very common when buying and selling a business, this plays quite heavily into a business valuation.
If we lived in an ideal world, it would look like this; The seller receives a cash payment on Day 1 of the business sale and walks off into the sunset.
The buyer pays for the business out of the profits over 20 years and should the seller die in that period, the payments go to the sellers’ children.
Hence the reason ‘ideals’ are dreamt up.
The earn out is typically used when there is a disagreement initially on a company’s value. The seller wants more, and the buyer wants to pay less.
That word ‘potential’ comes into play here, the seller thinks that his or her business has a huge potential to earn in the future, but the buyer is unwilling to take that risk on, and the future performance of the business is uncertain.
They say that Year 1 of owning an acquired business is all on the seller and by year 3 its performance sits with the new buyer.
The earn out is based upon the financial future performance of the business that is sold and acquired, therefore, a financial agreement gets put in place which allow the seller to receive an additional compensation for an increased future financial performance of the business but a decrease in deferred payments for a negative financial future performance.
Basically, there is a deferred payment element involved over (maybe 5 years) and each year the business must perform to a certain level and hit certain targets (usually) from a financial perspective to achieve a certain figure yearly or quarterly from the new acquirer.
It usually stems from the disagreement where a seller wants an inflated price and the buyer says that he or she has no problem paying that provided that the profit margin is X%, let’s be honest it doesn’t really matter to the buyer or the seller if the maths makes sense because the numbers are just percentages.
It allows the seller to be involved with the handover or transition process of the new acquirer and it also gives the seller an incentive to help the buyer out in the future too as the sellers’ payments will be higher.
It also helps to mitigate the risk of the buyer so that the buyer doesn’t get duped into paying too much money for the business in the first place.
It also protects the buyer against the manipulation of the business performance and results that can happen in the world of business, accounting and manipulation of figures.
e.g. if a company is worth £5M today and the seller believes it could be worth £10M in 3 years’ time, then maybe a deal is done that the buyer will pay an additional £2.5M in 3 years should it hit that target.
Conclusion
The truth is that it costs more money to liquidate a business in the UK than it is to sell a business.
The truth is that about 80% of businesses that go onto the market in the UK do not sell, this does make me quite sad and I believe that the government should be doing more to help these businesses as opposed to crippling them, it would help the economy and the UK much more and put us in a better state than we currently are on the world leaderboard.
Now valuing a business go far beyond the multiples of EBITDA and you are probably even more confused now after reading this blog, the truth is that a business is only worth what it is worth to somebody else regardless of your time, effort, energy and staff. It is not emotional; it is just business.
Numerous factors come into play:
- The limitations of balance sheet valuations
- The critical importance of cash flow
- The distinction between selling a business and selling a job
- The value of robust systems and management structures
- The impact of debt on business value
- The nuances of earn-out agreements
Ultimately, the true value of a business lies in the eyes of the buyer. It’s a delicate balance of tangible assets, financial performance, future potential, and intangible factors like brand value and market position.
For business owners considering a sale, the key takeaways are:
- Start preparing early, even if you’re not planning to sell soon
- Focus on creating a business that can run without you
- Implement strong systems and processes
- Build a competent management team
- Maintain healthy cash flow and manageable debt levels
- Be realistic about your business’s value and open to negotiation and deal structure.
Remember, valuation is as much an art as it is a science. While financial metrics provide a foundation, the final value often comes down to negotiation between buyer and seller. By understanding these various aspects of business valuation, you’ll be better equipped to navigate the complex process of selling your business and maximizing its value.
Whether you’re a potential buyer or seller, it’s crucial to seek professional advice from accountants, business brokers, and legal experts who can guide you through the intricacies of business valuation and sale. Their expertise can help ensure you achieve a fair deal that reflects the true worth of the business.
If you need any further information or wanted us to look at your business, then get in touch on info@sjacquisitions.co.uk
