Thinking of selling a business? Do you know how much it is worth?
For many business owners, how to value a business remains a mystery, despite most having at least a rough idea of what their home is worth! Taking the time to create an accurate business valuation is not only informative in terms of retirement planning, but will also provide you with some key strategic drivers to increase the value of a business over time.
A business valuation is the result of two key factors: risk and reward. But within these there are many factors to consider, as not all risk and not all returns are created equal.
Evaluating risk in selling a business
The most obvious risk is “key-person risk”: how dependent is the business upon the owner/s? What about other key people within the business?
Is the business likely to be affected by disruption? Think of the industry changes to video stores and taxi cabs. Whether buying or selling a business, there are plenty of risks to consider: competitors, economic changes, employee, fraud or corruption, and OH&S, to name a few.
It’s important not to turn a blind eye here; identifying as many of these risks as possible will give you a more accurate idea when valuing a business. As with any investment, the higher the risk the lower the value, but this is certainly true of any privately held business.
Looking at rewards in valuing a business
Reward (or return) is also worthy of review. Firstly, reward equals profit. However, not all profits are equal because not all income is equal. A business with ongoing contracted income, which is therefore recurring and predictable, is far more valuable than a business which needs to make new sales to generate revenue.
The combination of risk and reward will drive the valuation multiple. When talking about listed companies this is often referred to as the price to earnings (PE) ratio. This ratio is the key value driver for unlisted companies as well, so it’s worth considering what can we do to drive this multiple higher and thus improve our valuation.