We get asked this question on a fairly regular basis. The simple, if trite, answer is "whatever someone is prepared to pay for it". However, this does not help the debate much.
For those with a larger business (£50m+ turnover) there are several established, formula based ways of calculating a value, usually with reference to a multiple of earnings, which is set in relation to the market place in which you operate. This however, does not assist most of us with smaller, more parochial businesses.
For the smaller business, any purchaser is principally looking at the future profit stream he is buying to get some assessment of the goodwill value and adding this to his estimate of the fixed asset value. (The fixed assets in fact often amount to the purchaser's insurance policy- ie the minimum it is worth). The important point here is that a business owner can do many things to maximise the future value of this goodwill element, but that it is no good trying to do this in the six months running up to a sale.
Everyone will have to leave his or her business at some time, so why not plan for it?
Running your business every day as if it were being groomed for sale creates long term business value. Every buyer wants to obtain a 'turn key' operation i.e. everything is set up for him to walk in on the first day and continue trading.
It is not possible to ascribe a particular uplift to the value of your businesses goodwill based on one or more of the factors listed below, as the goodwill value is the most subjective part of the buying decision, and the sum of many parts. But getting these business development issues right will give you both a more enjoyable and saleable business.
A few of the areas you will need to consider:-
1. Does the way the business operates, give it competitive advantage-or is just like other firms in this market? (business model)
2. Does the staff share/understand this company ethos?
3. Is the business wholly reliant upon its owners? (deeply unattractive)
4. Do you have documented ways of doing things, or does the business rely on good luck or the commitment of the staff to get a result?
5. Do you have systems in place to monitor areas that are critical to success (eg phone calls/sales conversion)?
6. What is the cash-flow/generation of the business? Will there be a big funding need?
7. What is the trading record like? Can it be improved or tidied up?
8. Do you have experienced staff?
9. Will the new owner be taking on any onerous liabilities?
To expand upon some of these:
It sounds fancy stuff, but is probably the biggest reason why many business just survive and never achieve the objectives the owners had when they set out.
By way of example, if a group of 10 final year students all decided to set up as hairdressers in a town, their typical response would be for them all to hire staff, take premises, advertise etc. probably in ways which were little different from each other. All things being equal, they will probably end up with an equal share of the available business in the town. If this isn't enough to sustain them, then they will usually resort to a price-cutting spiral to get a greater share of the business. Contrast this to the one maverick out of the group who decides, at the inception of the business, to find out exactly what her clients want and devises a way of doing business to meet this. This business is likely to capture the lion's share of what is available.
The key point is that the real product of these businesses is not haircuts, or beefburgers (in the case of McDonalds) or wines (oddbins), but the way it sells to, and deals with its customers. Please read that again, it is a vital point.
At the risk of being sued, the McDonalds' product is not particularly remarkable. Why then, do nearly all of its franchises succeed (as opposed to the 80% of small businesses that have failed by year 5)? The answer is that the McDonald franchisees have bought a way of doing business that is successful (flipping burgers at a set time, layout of the shop, dialogue used by the staff, signage etc). Their business model is particularly relevant to the fast food market they service.
So how do you relate this to your business and enhance its sale value? Is it just like the rest, or is some way in which it does business particularly relevant to the marketplace it serves? What is your unique selling proposition? You are not allowed to use the words 'customer service ' in your reply- everyone has to be good at this nowadays. If you can't answer this immediately, then this needs to be developed before sale. It is the difference between an average performer and a shooting star.
The effective business model also has the secondary effect of improving another valuable part of the asset for sale- the quality of your business customers. Quality customers tend to be attracted to well run firms. If you can show a potential purchaser that your client base is made up of high value clients who buy from you regularly, at high margin, and are loyal advocates, then you have a valuable asset. Contrast this with the business which has high client turnover, customers who are price sensitive (because they cannot perceive any difference in value between you and a competitor), and little repeat purchasing.
Do the staff understand and share the company ethos? (and are they effective)
The best business model and plan will fail if it is not followed, heart and soul, by the people employed in the business. This is obvious stuff, but becomes increasingly hard to deliver, the larger the organisation.
A businesses people policy is crucial to success because it is only the people, and their interaction with others, that make the difference. Few of us can remember what we paid for our last meal at a restaurant or a hotel we stayed at, but we can remember how we were dealt with.
The owner of a successful and valuable business will always have taken the time to make sure his team understands the reasons for doing their work as part of the business model, a reason that is probably more important than the work itself. The team will share and understand the business model and be prepared to do their part. Their work is not just a job, but has meaning within the overall business model. (UPS 'consider it done'). To get to this stage, the business owner has to take the product of the business seriously and take the time to explain it to the people he employs. He must also always be the living embodiment of this reason why he is in business.
So when you come to sell, what is the potential owner buying in terms of staff assets? Is it a bunch of time served individuals whose motivation is just the money you pay them each week, or do they share a passion, your passion about the business? The latter is not an easy state to achieve. Can your team explain easily what your business is about and the way you do it? Go and ask one of them now. If they look at you blankly, there is work to do.
Reliance upon the owners
It is unfortunate, but most small business end up as just a reflection of the owner. They give the owner a job and little more.
It’s a myth to even suggest that most businesses are started by entrepreneurs. Most businesses are started by a person suffering from an 'entrepreneurial seizure'.
Think about how true that is. The hairdresser who’s working for a hairdresser gets fed up working for a boss and opens a hairdressing salon and, in so doing, she creates a job for herself. In truth, probably a worse one than she had before.
Where, in the past, she used to go home on Friday and enjoy the weekend, now she’s doing the books, thinking about the new advertising campaign, paying payroll tax, getting involved with the fact that one employee doesn’t like working with the other and vice-versa, worrying about what her prices should be, and worrying that a new salon just opened across the street.
What was once a 40-hour-a-week job has now turned into an 80-hour-a-week grind.
This doesn’t happen only to hairdressers—the butcher opens a butcher shop, the plumber opens a plumbing business, the mechanic opens a car repair shop, and so on.
Instead of creating a business that works, we create a business that is us. A business that often becomes all-consuming. And worse yet, when it all becomes too much, we sell our most precious asset for far less than it would have been worth if we had started with the end in mind.
“Most people work IN their business. The secret is NOT to work in it, it’s to work ON it so that you don’t have to work in it.”. M Gerber - The E myth Revisited
So what is the secret of working on the business as opposed to in it? Simply it means developing systems of doing the key operations and having a clear idea of where you want to get to with the business.
You can systemise the day to day things and humanise the one-offs. You will then have a business that is capable of running the majority of its functions without your direct involvement. You can choose to become involved only in those which need your particular skills as a business manager. If we go back to the Mcdonalds example, the owner of one of their franchises can, without any interference, always expect its customers to be asked "Is that large or regular fries with your meal" (even though you will not have asked for it) because that is the way they do it in Mcdonalds. Similarly, he knows that the tables and floor will be swept at a certain, pre-determined interval. He does not have to intervene to ensure this is done. He merely has to check the schedules to ensure that the set processes are being followed.
Do you have systems in your business for all the day to day things or is it just reliant upon your intervention, or the commitment of a few good staff to get a good result? Without these systems and procedures in place for everything, the new owner will not have same chance of achieving your results and therefore be less willing to pay a premium. Also, the ability to demonstrate to a potential purchaser that you have systemised the way of doing things which produces a known result will give confidence in the predictability of your profits.
Monitoring the key performance indicators (KPIs)
In any business, there are a handful of processes that are key to its success. For example, one of the KPIs for an insurance company might be the conversion rate from cold calls to sales. A garage may be the recovery of its hourly rate, for a Bank it would be the Customer Satisfaction Index or the number of sales meetings its managers have had that week. Most businesses have between 3 and 12 key indicators. In fact, a business is just a series of processes for converting inputs into a profit. Everything in the business, such as labour, customers, capital, are mixed together in the 'business washing machine' and the result is a profit or loss. Unfortunately, many owners do not take apart the individual processes to see how they work and how they can be improved.
The successful business owner will have identified key processes and check them as his quick way of monitoring the health of the business.
Most still rely upon monthly or quarterly management figures (or worse still annual accounts!) to know how well they are doing. These measures are all historic and only measure the end result of a series of businesses processes, at a time when it is often too late to do anything about a part of the business that is going wrong. It is far more productive to monitor key parts of the business process as they happen (weekly if required), and adjust accordingly.
The business that is tightly and simply controlled is therefore a far more attractive purchase than one where there is little monitoring. At one extreme is a business where decisions are based upon instinct and out of date annual accounts to one where the key processes are monitored weekly. Where does your business lie and have you honestly tried to identify your key processes?
The potential buyer seeks a future profit and cash flow from his purchase. While a business may have a sound profit record (see below) there can be a problem with its purchase, if the terms of trade are such that it has a large cash requirement to fund its stock, debtors etc. Contrast the cash requirement of a double glazing business (no cash required) to a heavy engineer (long credit terms, low profits, high funding cost). Sometimes it is not possible to materially alter the way in which you do business with suppliers and customers, but the act of focussing on this area can improve your business performance and make it a more attractive purchase.
You will need to prove the size and regularity of your cash flow, preferably with accounts going back several years.
Tidying up your performance.
This is the one thing that virtually all business owners can do, with professional help, to make their financial statements look more attractive. Also, it will help a prospective purchaser if you have produced a set of figures to show how the business would look with a new owner.
This activity is not done in any way to deceive a potential purchaser, but to take out the impact of actions which you, and your accountant, may have done to minimise taxes. You may have given yourself and family members as many perks as possible, ploughed profits back into capital improvements etc. But now that you are considering sale, you want to reverse this trend. Your accountant can adjust your past trading performance to reflect what the figures would have looked like if:
• You removed your salary and perks, and those of family members who would not be expected to stay with the business post purchase
• Non recurring investment income or non operating expenses are removed
• Remove interest payments on loans as you will not be passing these on to the new owner
• Similarly, the balance sheet can be adjusted to reflect:
• Assets that will not be sold with the business
• Liabilities that will be cleared at sale(e.g. loans)
• Unrecoverable debts and obsolete items of stock
Finally, your accountant can take these adjusted figures and project them forward for the next five years to show, based on reasonable assumptions, how the business could perform. Why not help the buyer to make his decision rather than leave it to the cynical attention of his accountant who hasn't any idea about how your company operates?
Your purchaser is bound to get solicitors and accountants involved in the purchase, so it is no use hoping that they will not be aware of potential long term liabilities.
Why not bring these out into the open and demonstrate to the purchaser that you have made a reasonable assessment of them, in coming to the price you are asking for the business? If you do not do this, you will only give the buyer ammunition in the price negotiations. (Incidentally, a buyer who just buys the assets of your business will probably not have to worry to the same extent about these aspects, but in turn, you will not be getting the true value of your life's work by selling a bunch of assets.)
The areas of long term liability are often specific to your industry, but may include:
• Ongoing liabilities to staff under employment legislation
• Employee lawsuits
• Environmental liabilities
• Performance contracts
• Insurance disputes
• Product liability
• Revenue investigations.
If you haven't addressed them, do so well before the sale, to stop the purchaser thinking that there may be something nasty lurking within your business,or giving him a distraction at the point of sale.
I have deliberately played down the obvious factors in the sale prospectus to keep our focus on those issues which are often ignored- probably because they are harder to get right. (In the obvious category you should include: customer base, frequency of purchase, average sale value, market leadership, revenue growth, profitability, marketplace growth, competition, statutory regulation, patents, protected markets, supplier power, location and diversity of markets)
Business owners often ask for some rule of thumb they can apply to their business to estimate value such as a multiple of earnings after certain adjustments are made. But this is only the start. The important point is that value is not the same as price and buyers generally are value not price sensitive. Creating, sustaining and maximising value requires the drive and vision of the business owner. A drive that includes a desire to run the enterprise as a true business not just as a means of employing him.
Even if you don't want to sell your business in the next couple of years, take the steps outlined above if you want to maximise the value of your business.
Developing your business as if it were the prototype for a new franchise is a guaranteed way of making your business more profitable and valuable. This is not an easy thing to do as it requires a systematic approach and commitment to change. The really encouraging thought though, is that for each £10k you add to the bottom line, you could be getting £30-100k uplift in sale value.
Your Company Is Worth What You Can Get. Joshua D. Wachs
The E Myth Revisited. Michael E Gerber
Contact David Lloyd at Duckett: email@example.com