How much is your business worth? In the end, whatever a buyer will pay for it, on terms you’re prepared to accept. That sounds like a dodge, but it’s the reason the number in most owners’ heads doesn’t survive the first conversation with a buyer. It’s often based on what a friend sold for, an online calculator, or what you need to retire, and a buyer isn’t interested in any of those.
I’m a solicitor rather than a valuer, so I won’t pretend to value your business for you. What I see, from acting on sales, is how the number gets built, and how it changes between the first offer and the money arriving. A good deal of that change comes from things that are within your control.
How owner-managed businesses are usually valued
For most profitable owner-managed businesses, the starting point is a multiple of earnings. The earnings figure is usually adjusted EBITDA, meaning profit before interest, tax, depreciation and amortisation, adjusted to strip out one-off costs and anything that won’t continue under a new owner, such as your salary being well above or below what a replacement would cost, or the family car.
The multiple is the buyer’s view of how risky and how attractive those earnings are. It varies by sector, size, growth and a long list of other things, which is why published “average multiples” are of limited use for any one business. The arithmetic shows why the multiple matters so much, though. If your adjusted earnings are £500,000, the difference between a multiple of four and a multiple of six is £1m, and the business is the same business either way.
Other methods exist. Businesses that are mostly property or assets may be valued on their net assets. Professional practices and client banks are often priced by reference to recurring fees or income rather than profit; I’ve written about how that works when buying or selling a client bank. But for a typical trading company, earnings times a multiple is where the conversation starts.
What moves the multiple
Some of it is commercial and has nothing to do with lawyers. Recurring revenue is worth more than one-off project work. A business where one customer provides a third of the turnover is riskier than one where no customer provides more than five per cent. A business that depends on you personally for its relationships and its decisions is worth less to someone who is buying it so that you can leave.
The legal side matters more than people expect, because buyers price risk and the documents are where they find it. Revenue that looks contracted but sits on terms either side can end on a month’s notice is not worth what contracted revenue is worth. A key customer contract that lets the customer walk on a change of control is a problem the buyer will want solved, or paid for. Key staff without enforceable restrictive covenants look like people who could leave the week after completion and take clients with them. Software or designs created by a founder and never assigned to the company raise the question of whether the company owns what it’s selling.
None of those necessarily reduces the headline price. More often the buyer keeps the price and changes the terms, which brings me to the part most owners underestimate.
The headline price isn’t what you receive
Two offers at the same price can be worth very different amounts. One might be mostly cash on completion. The other might be half on completion, a quarter deferred over two years and a quarter in an earn-out based on profits you’ll no longer control. The second is worth less, however the numbers are presented, and I’ve written about the risks of deferred payments separately.
Most deals are also done on a cash-free, debt-free basis with a normal level of working capital, which means the price is adjusted on completion for cash, debt and working capital. That can move the amount you receive in either direction, sometimes by more than sellers expect; there’s more in my article on what cash-free, debt-free means. Then there are the costs of the sale itself and the tax on the gain, both of which come off the top.
So when you think about what the business is worth, it’s worth asking what it would be worth to you, after all of that, rather than stopping at the headline.
Getting a proper number
If you want a valuation you can plan around, you need someone who values businesses for a living and will look at your actual accounts, your adjusted earnings and recent comparable deals. I introduce clients to corporate finance advisers I trust for this, and they quote for it directly. Your own accountant is also a good place to start, particularly on what the adjustments to your earnings should be.
It’s worth doing before you speak to a broker or a buyer, because without it you’ve no way of telling whether an offer is fair, generous or low, or whether another year of work on the business would move the number enough to be worth waiting for.
What to do now
Find out your adjusted earnings and be able to explain every adjustment, because a buyer’s accountant will recalculate them and anything you can’t support will be dropped. Look at your five biggest customers and check what their contracts say about notice and change of control. Check that key staff have proper contracts, and that the company owns its intellectual property. If you’re two to five years from selling, that’s enough time to fix most of it; my page on exit planning explains how I approach that, and the exit readiness scorecard is a quick, free way to see where you stand.
I help owners of small and medium-sized businesses prepare for and complete the sale of their business, working alongside their accountant and corporate finance advisers. Get in touch if you need some help.
Written by Steven Mather, a business solicitor acting on company sales and purchases. This is general information about the law, not legal advice on your situation.
Written by Steven Mather, a business solicitor acting on company sales and purchases. This is general information about the law, not legal advice on your situation.
