Many of the businesses we talk to raise the issue of how to value their business. Unlike shares in a publicly listed company like BHP or Commonwealth Bank, there’s no way to track value on a day to day basis.
Understanding the accurate value of a business is a challenging task and requires a deep understanding of the industry at hand and how a business operates within that industry. Talk to us to discover the maximum value of your business.
We start with a few fundamental questions about the company structure before jumping in to the valuation side of things:
- How many shareholders are there and what is the ownership structure? Is it a company with directors who own holdings, are there any personal holdings or trusts, and is any or all of the company held in a superannuation vehicle?
- Is there a shareholder agreement governing all shareholders?
- What are the rights of shareholders per the shareholder agreement – does each shareholder need to agree to the sale?
For the purposes of this example, let's assume the following:
- 2 shareholders own 50 per cent each in a manufacturing business making $20m revenue and $3m of EBITDA.
- One wishes to sell and the other wants to remain in the business but is open to selling part of their holding.
- Both hold their shares in their personal names and there is no shareholder agreement governing the arrangement.
This is a common scenario that our team comes across. In this example, we look to value the business as a whole. Once we've done that, we distribute the value to each shareholder proportional to their shareholding (i.e. 50 per cent each). Often there is a case for one shareholder's shares being worth more than another's - based on the size of the shareholding, their legal rights, and whether the shareholder is involved with the day to day running of the business or not.
How do you value a private business?
There are a few ways to go about valuing this business. The typical method is to use a multiples approach. This is based on a multiple of EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation).
In the example above, a manufacturing business is typically valued between 3-4x EBITDA. This suggests the business would be valued at $9m - $12m.
Tax and the cost of debt can vary a lot between companies and in different countries, so EBITDA is typically used to normalise for these variables. This gives a more accurate picture than using net profit or profit after tax.
Other approaches are to:
- consider the company versus listed company valuations
- consider the company versus recent market transactions
- perform a discounted cash flow or other cash returns-based valuation model.
Understanding the industry multiples
Industry multiples for manufacturing businesses vary depending on the type of manufacturing, the intellectual property and specific factors related to the business itself. These can range from:
- How automated the facility is versus industry standard
- The location
- The customer base
- The uniqueness of what they are producing
- The state of the industry
- Global trends for offshoring or onshoring of manufacturing capabilities
As such, it is useful to find a similar business which has recently sold or been acquired and use that as a benchmark for the EBITDA multiple to establish a valuation guideline.
Other complications when calculating a private company’s valuation is taking in to account the various business-specific factors which can add or subtract value. We detail some of these in the sections below:
How attractive is the industry the business operates in
At any time in the economic cycle, different sectors will be considered attractive for investment or acquisition.
At one point in the last 15 years, retail, consumer goods, technology, financial services, food and beverage, and advertising and media have all been the most sought-after sector. Whereas in recent years, retail and financial services are in low demand.
Identifying which sector the business fits in to will ensure the right buyer is attracted and valuations are appropriate.
How many clients does the business have?
Are they contracted or ad-hoc and is revenue from clients predictable or project-based? In order to accurately calculate the value of a private business, a buyer will need to ascertain:
- The certainty of cashflow, determined by the amount of and length of contracts and,
- The concentration of cashflow, determined by the number of different customers and the amount of revenue each customer represents. For example, many customers each representing a small part of the overall revenue is best, compared to a single customer representing 70 per cent of revenue.
Continuity of owners and key executives
A buyer looking to purchase a private company may already be in the industry or can be a party looking to diversify into a new sector. In either case there are two key considerations for the long-term success of any acquisition:
- Maintaining continuity of the business. Often, this is with the owners remaining involved for a period of time (typically six months to two years)
- Ensuring key executives and management stay in the business.
How you structure a sale, with earnouts, transition periods, management share plans, and other incentive mechanisms will help to temper a buyers concerns and potentially improve the value of a private business.
By considering the variables, as well as any specific factors which affect your business, you can work towards a valuation range for a private business.