Valuing Your Business
In this eclass you are going to learn the essential skill of valuing your business.
This is a CRITICAL skill that you need, but is quite simple to learn. It will help you assess the current value of your business and show you the areas of your business that a buyer will be willing to pay the most money for. When you know this, you are on your way to building a business the SMART way – by focusing on the things that will give it a strong and valuable foundation.
How To Value Your Business:
There are many ways to value a business and an almost unlimited number of factors that youc an consider, but we want to keep this really simple. From our experience in business broking, many multi-million dollar businesses were initaiily valued using this “back of a napkin” method, and 9 times out of ten it was spot on!
The easiest way to value a business is to use two components – the first being the Profit, and the second being the Value Multipliers.
These two factors interact to create the “valuation”, or price that buyers are most likely to pay for the business (the true value of the business is only realised when a buyers actually lays down the dollars)
If you haven’t seen one of our webinars on valuing a business, then click on the video below to see how the Net Profit and the 5 Areas of Value are used to calculate the value.
The technique shown in the above video is used by every business broker and savvy business investor to value a business, or immediately recognise if a business is over-priced.
In summary, business valuations are generally based on Return On Investment (ROI), because when you put money into a business it’s just like investing in shares or property – you want to see a return on that money. It is generally accepted that an investment into a business should get at least a 30% return. For example, if a business costs $300,000, it should make at least $100,000 in net profit back each year.
This equation also works the other way around – so a good business that has an adjusted net profit of $100,000 will generally sell from 1-3 times that figure. This is called a “profit multiplier” and is used by most brokers and investors to quickly value a business.
In the following video, we will show you step by step how to calculate the Adjusted Net Profit for a business.
To access this video you will need to enter the username: delta and password: zenith
So the basic steps for calculating the Adjusted Net Profit are:
- Look at last 3 years and YTD financial statements (or management accounts, if not audited), including profit and loss statements and balance sheets
- Create a separate table that shows sales/turn over, net profit before tax, Add Backs and the Adjusted Net Profit (or EBITDA) – you can download our version by clicking here
- Go through each expense item that can be added back (see below for list of common Add-Backs) and note down the amounts for each item, for each year
- Come to an adjusted net profit figure (EBITDA) for the business for each year. Then take an average for the last three years to give and average EBITDA that you can use for valuing the business.
Key Add Backs to look for are:
Owner’s personal expenses and other owner perks that may be buried in other expense categories that may not be a necessary expense to the business. The most common ones to look for are motor vehicle, telephone and travel expenses.
Interest – always treated as an add-back because everyone’s interest expenses will be dependent on their own personal circumstances.
One-off expenses that would not be expected to be an expense again. For example; the building of a website, which is an expense you would not expect to see every year.
Owners Salary & Super – these are often inflated, especially super. Note that most accountants disagree that you add back owners wages as there needs to be an allowance made for a wage for someone to run the business. However, our experience in dealing with a wide range of buyers is that every business operator will have a different view as to what is an appropriate salary so you need to add this back initially. Always take careful note of the owners salary and super, especially in small businesses.
Depreciation – is generally added back (again, some accountants disagree with this) or adjusted to reflect the actual decrease in asset value each year, which may be considerably different than the depreciated amount on the financial statements.
Remember, we are trying to build up the net profit figure in order to determine the real amount of money that the business returns to you the owner.
Now the big question…
What profit multiplier do you use to calculate the value of a business? Do you multiply your net profit by 1x, 2x, 3x or more??
The answer relies on the strength of your business in the Value Multipliers. The more valuable the Multipliers, the higher the profit multiplie that buyers will be willing to pay.
THE VALUE MULTIPLIERS in a BUSINESS
The customer list, or database of a business is it’s lifeblood, so of course this is an area of great value. But it is the QUALITY of a list that increases value more than just the size.
Many businesses have no list recorded at all – especially retail shops and other high traffic businesses. There is enormous potential to quickly increase sales and value in any of these businesses.
For example – we went into a small cafe recently and they asked me to become a VIP customer and go into the draw to win a mobile phone, in exchange for my name and phone number. A few weeks later it was Mother’s Day, and I got a nice message letting me know that they were open for Mother’s Day and they had a special mother’s day treat for me. Guess where we went for Mother’s Day and spent $45??
That business is building a valuable list and a valuable relationship with their list. Not only is it increasing their profits now, but when they come to sell, a buyer may be willing to pay a higher multiple of the profit because of the value of that strong list and relationship.
The second point is that many businesses that already have a list aren’t using it.
It has been shown that it is up to 8 times more expensive to acquire a new client than it is to sell to an existing client.
This means that if you have an existing list, but aren’t taking advantage of it – you have a business that has potential to increase profits and value very quickly. This is because it is far easier and more cost effective to work the existing list rather than the 8 times more expensive practice of chasing new clients (which is where most business owners think they need to focus).
These opportunities are everywhere. Believe it or not there are even big blue-chip companies with golden databases of clients that are under-utilised.
Let’s take Harvey Norman for example. They gather every detail from anyone who uses finance to purchase something from their store. Their list must be HUGE! But I have never received a letter, phone call, message or email asking if I would like a matching coffee table to go with the TV cabinet I bought there…and I would probably say “yes” if they just asked. In the renovation part of this program, we’ll go into more detail about how you can quickly add high value to your business list.
Systems are highly prized and valuable because they are what frees the owner from the business and gives them back lifestyle. Buyers and Investors will pay handsomely for a highly performing system because a well-systemised business will not only produce consistent and reliable results, it will deliver those results with the least amount of effort from the owner.
The more systemised the business, the more valuable it is. Franchises are a great example – they are sold for 3-5 times multiples of profit and even fetch hundreds of thousands of dollars when they are brand new and showing no profit. This is mostly because of their strong systems.
The property from which a business operates is a vital part of it’s value and success, especially for retail businesses that rely on passing traffic. The classic example is McDonald’s – when Ray Kroc was asked what business he was in, he didn’t say “burgers”or “food”, he said “real estate”.
Just like in residential property, the condition of the business property influence the amount that a buyer may be willing to pay. It doesn’t matter what industry you are in – even if it is industrial – buyers and customers will make judgements about the value of your business and your service based on the condition of your property.
We find many business owners get slack about maintaining the property of their business. This includes the physical premises, the signage, the furniture, the tools, equipment and machinery and also the online property such as the website.
There are simple and fast ways to renovate a business property that make it impressive to buyers and customers, and will instantly increase value and profits, which we’ll reveal in the renovation phase.
The wealthy look for strength and positivity in brand – that is the public perception of the business. There is value in a brand because it reduces the risk of the business, and it can increase the profit multiplier significantly.
Again, take franchises as an example, where the value of the brand and systems means that a well-known retail franchise can sell for up to 6x net profit, and over $1 million for a new store with zero profit.
A brand that communicates your businesses uniqueness and benefits will not only make your business more attractive to buyers, it will also send a clear and positive message to your clients and potential customers.
5. INTELLECTUAL PROPERTY
The intellectual property of a business relates to the unique aspects of the business. This may be a unique product or service, a specialised design or a unique system. These things may be protected with patents or trade marks, or they may be hard to replicate because of the time, research or money required to develop them.
These qualities increase value by making a business more competition proof. The more unique and protected the intellectual property, the lower the competition, so the more valuable the business is.
In larger businesses, a great deal of money may be spent developing Intellectual Property (take Pharmaceutical Companies for example), in smaller businesses and online business you can increase value by developing unique ways of providing your service or creating small software programs that are unique to your industry or niche.
One example is a building company we knew that developed a software program for quoting jobs. They were bought out for multi-millions by a big publicly-listed company who wanted to own and use the program.
How much is your business worth right now?
Task for this week:
- Work out your Adjusted Net Profit – you can do this yourself, but it is also a good idea to have your accountant go through the process with you as well.
- Download the Business Value Estimator worksheet and rate your business in each of the Areas of Value, follow the instructions and use the score to estimate a Profit Multiplier.
- Estimate your business value by multiplying your Net Profit by your Profit Multiplier.
- Enter your answers and your businesses strengths and weaknesses on your Renovation Roadmap
Find out how a buyer will value your business:
We have created an easy-to-use application that is designed to help buyers assess the value and potential of a business.
“The Deal Profiler” takes you through the valuation process. It automatically calculates a Profit Multiplier and an Estimated Value, and gives you a full print out of your ratings.
If you are a Deluxe or Gold Member you will have access to this tool in the top menu bar.
We highly reccomend you learn how to value a business and get to know the sort of questions you need to ask – The Deal Profiler condenses our knowledge and insights, plus those of our top high net-worth clients and mentors. We created it so you can get instant access to this incredible bank of experience.
If you would like to upgrade your package to include the Deal Profiler, just email us at [email protected] with “Deal Profiler Upgrade” in the subject line
Your Next Step..
Now you need to compare your estimated value to the figures you were given by the Business Brokers. If it is widely different, then you may have to go back and rethink the values you attributed to each Area of Value. Make sure you are totally honest with yourself, you can’t improve if you try to ignore problems that exist.
This exercise can be a real wake-up call. It should be giving you a good sense of the strengths and weaknesses of your business, and where you should start looking for areas you can improve.
In the next Eclass…
We’re going to give you a run-down of business figures. Many business owners don’t understand their figures, or rather don’t understand what their figures reveal about their business.
We’ll go with the 80/20 rule again and give you the top things you need to know to be able to make a great profit, and have a highly valuable business.
In the meantime, if you have any questions, just email us at [email protected] and we’ll be happy to help.
See you next week,
Matt and Liz