If you’re selling or planning to sell your business, it makes sense that you want to get the very best price. We asked Mark Hamilton, Director, Bentleys Newcastle for some tips to help you.
Mark began by quoting respected author, Steven Covey, who said “begin with the end in mind”.
“This is great advice to anybody starting a business, as if you have a vision of where your business is going to be, and then a plan as to how you intend on getting there, it is much more likely that will happen. Furthermore, if you understand what you should be concentrating on to maximize the value of your business, that plan has just got a lot more powerful,” Mark said.
Basis of the value
To understand the activities that will maximize the value of a business, you should have some understanding of the basis upon which the business will be valued. Mark said that whilst there are several methods used, the most common is the Capitalization of Profits Method.
This uses your adjusted Earnings Before Interest and Taxes (EBIT) and Capitalization Rate. Therefore, to increase the value of your business, you need a higher adjusted EBIT and a lower Capitalization Rate. It’s all about creating strategies for improving the Net Profit of your business.
“The fact that Interest and Taxes are added back to obtain EBIT means you don’t need to be concerned about these items – at least from the perspective of a business valuation,” said Mark.
“There are many strategies that can be applied to improve the profitability of a business and, to a degree, they differ for each business.”
Mark has broken down those strategies into the following:
Volume
For example, how many customers you have, how many times they interact with you in a given period or how much they spend on each interaction.
Pricing
This needs to be considered in comparison to the direct cost of sales i.e. the outcome is what gross margin you make from each sale. It can also become a decision as part of your vision as to the type of business you will have e.g. low price/service or higher price and better levels of service.
Efficiency
For example, efficiency of production, ability to turn around a sale quicker or ability to keep overheads at an efficient level compared to sales levels.
“Specific strategies around these three areas will help you to achieve a better bottom line and the sooner this is started the better,” Mark said.
“In addition to implementing strategies to increase the bottom line, consistency of profit is also something that should be aimed for as this will assist in providing a better Capitalization Rate.
Capitalization rate strategies
Mark explained that the Capitalization Rate is largely a product of risk. In other words, the lower the level of perceived risk, the lower the required return by a prospective owner. There are many factors that can affect risk – here are some of the most important:
Owner dependency
The more dependent the business is on the owner, the greater the risk will be that when it is sold and the current owner leaves, that business will not function as well. Systemizing and putting in place employed management teams can reduce this risk.
Customer contracts
Where customers are under contract or there is more certainty of them returning (repetitive work), the less risk there is that turnover will decrease on a change in ownership.
Customer concentration
If a business has a high proportion of its turnover from a low number of customers, there is a greater amount of potential turnover and potentially 100% of profit that could be lost in losing one customer. Where this is unavoidable, customer contracts will help mitigate this risk.
Supplier contracts
Having an uncertainty of the price that will be paid for essential supplies by a business (through a lack of supplier contracts) can lead to a risk that margins could be reduced, especially where there is a high degree of competition in the industry.
Supplier concentration
This particularly applies with critical supplies, where there is a lack of alternative suppliers, or where a business’ success is built on a particular brand. This can lead to a risk of price changes affecting margins or if the supplier closes down, an inability for the business to function.
Key financial data trends
Is turnover increasing? Has the rate of increase stayed consistent? Has the gross margin rate increased?
Is overhead growth outstripping margin increase? How has liquidity changed? How do the key financial results compare to industry benchmarks?
Barriers to entry
Are there barriers to entry in the form of special skills, large or specialized equipment or specific industry certifications? This will restrict the level of competitiveness in the industry the business operates in.
Competitors
Where does the business stand compared to its competitors e.g. are the competitors dominant in the industry and how many other competitors are there?
Key staff dependency
How dependent is the business on key staff and further, are those staff likely to stay with an ownership change?
Premises
Particularly if the site from which the business operates is important to the profitability of the business. Knowing whether the length of tenancy is enough to provide an adequate return given the value to be paid.
“At Bentleys, we believe that assessing the above risk factors and others, as well as maintaining vigilance over the business’ performance on a regular basis, will not only help the business thrive during its years of ownership, but will assist in providing a better sales price when it comes time to sell,” said Mark.
About Mark Hamilton
Mark has 34 years of experience in tax and business consulting. He loves to help clients grow their businesses and improve their financial position, by being involved in the important decisions they need to make. Running is Mark’s passion; having completed several half-marathons, he has now set his sights on going the full distance, with the help of ‘Macca’s Mob’. To contact Mark, email [email protected]