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How to avoid business valuation traps

by LLB Finance Reporter
1st Jul 22 8:59 am

Selling a business can be a big step in someone’s life and one that needs careful consideration. The prospect of valuing your business can be daunting, especially if it is not making a profit, but there are plenty of resources to help you.

In this article, Raymond Blin, a Regional Partner with Business Partnership, a national business broker, advises on how to avoid valuation traps and find the value of your business, no matter your situation.

When valuing a business for the open sale market a multiple of net profit is often the most important guide. That multiple can very much depend upon the strength of the brand. The other matter business owners have to consider is how much of that sale price ends up in your pocket as the owner. A business sale will also incur other fees to any professionals you use – broker, solicitor, accountant etc – and maybe costs for a refurbishment to bring a retail site up to latest brand standards. All these costs should be detailed.

Below are my top tips to valuing your business and what traps to avoid to ensure you find the right price for your business.

Valuing a successful business

When it comes to valuing your business, the first thing to consider is whether the business is performing well or not. Determine the true net profit of your business by bringing your accounts up to date. Then get both annual accounts and year to date management accounts to show a buyer what the profit is. It is hard to sell a business without these figures. “Trust me we are making money” will not work for most buyers and certainly not their funders.

A broker would then apply a multiple to this profit. The multiple depends on several factors, including the brand strength, stability of the business’s cash flow and the forecasted business growth. A profitable business is usually valued at between one and five times the net profit. An existing and already profitable business has that income, so remind your potential buyers. Remember, business resale valuations are never exact, and you may have different expectations for the business, so the next step in the process is negotiation.

Valuing a failing franchise

Unfortunately, not all businesses succeed so how do you value one that is failing? A good place to start is to find out the total cost of similar businesses in your sector and any required investment in equipment or refurbishment of the building. This is an entry point for anyone interested in your business. And if you have a retail business, the good news is your unit may be more valuable than you realise, for example good contracts and well-maintained equipment or other similar assets can help the price of a business.

If, however, your business is growing and the turnover is increasing but currently unprofitable, you will need to provide some forecasts to show that the future is looking better.

And if your business has faced temporary issues, such as roadworks which reduced footfall to the business, but is expected to recover to previous profit levels, you might take a 15 per cent discount from your valuation. You will then be expected to provide historical accounts and fully explain the situation to give the buyer a full understanding of the circumstances. I recommend researching your industry and finding out what other struggling businesses have sold for. Speak to a professional insolvency practitioner who can advise on this.

The valuation traps in business

Whether it is because someone is planning to take a step back, or ready to let go and try something new, almost every business owner reaches the stage where they want to sell their company. It is crucial to carefully design your business sale that you do not set unintended valuation “traps”, which could hinder the effectiveness and increase the costs of your transition.

1. Look at your business from a buyer’s perspective

When you have spent years of hard work and finances building your business, it is often difficult not to see it through rose-tinted glasses. However, look at it from a buyer’s perspective. Forget that you know everything. Assume your buyer knows nothing. Ask yourself, if you were buying the business, would you be offering a top price or discounting it?

2. Profit is key

Another pitfall in the sales process is thinking your business is more valuable than it really is because it has a high turnover. Unfortunately, this is not the case. A business’s value comes from profits, not turnover. So, when setting an asking price, make sure you factor this in; otherwise, the likelihood of selling your business is massively reduced.

3. Do not be flattered

Try not to be overhasty when accepting a higher-than-expected valuation. If a great valuation is provided by a broker, question how it was arrived at. If you are offered a price which seems too good to be true, it often can be unachievable.

4. Free versus fee?

When it comes to having your business valued, you often have the chance to get either a free valuation or a paid-for valuation. Both have their place in the business world, but a paid valuation will go into much more detail, which is far more beneficial when it comes to something important, like selling your business.

Finding the value of your business is an intimidating process if you do not know what you are doing. So, I recommend consulting an independent business broker for advice when it comes to selling your business. It is also worth discussing the resale with an accountant or lawyer with experience in the franchise industry. They will be impartial and able to offer support during the negotiation discussions. By following these steps, you will be able to find the value of your business, no matter your situation.

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