Which valuation model to use?

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Okay, so your client wants to know how much their business is worth - how do you deal with this question?

Let's talk theory first.  There are 4 acceptable valuation models.

  1. Price/Earnings Multiple method - you remember this one, it's about calculating the maintainable recurring earnings (taking average EBITDA after adjusting for add backs, then taking off Corporation Tax) and applying a suitable multiple.  And this is the huge challenge - what multiple?  Most SMEs in this market can expect 2-5 times earnings; the BDO Private Company Price Index stands currently at just over 12, (but this is for mid-market transactions average size £13m) and let's face it, we could argue for hours about what this figure should be.
  2. Assets basis - ideal for property or asset-intensive businesses (such as farming) where the P&L is just a sideline to the main business of holding assets - obviously use current values, not just book values
  3. Dividend basis - generally only relevant for listed businesses
  4. Discounted cashflow - lovely for the excel enthusiasts!  Use projected cashflows (oh dear, the problems start here!), then discount to present value using appropriate cost of capital.  Useful where minimal trading results, or significant investment needed to turn it around. 

So which method should you use?

Well, the most SME-appropriate methods are a mixture of 1 & 2.  P/E plus major assets, such as L&B.

However, let's add a dose of reality.  I've just been running through some case studies of acquisitions with one of my firms and these real-life deals really brought it home to them.  in each case, my client was willing to pay what they could afford to.  They looked at the unencumbered assets of the business, the facility they could obtain from a lender, and added whatever resources they had.  What's this got to do with the theoretical valuations above?  Not a lot! Except it's a line in the sand that the vendor would probably want to work to.  And when you're bidding for a business in a competitive environment (with a vendor or an IP), you've got to bear in mind what the seller is going to want versus what most purchasers can afford to finance (there are very few cash-rich purchasers around for SMEs).

Now obviously each potential purchaser will have:

  • a different level of resources available to him/her
  • different requirements for taking that business forward (a competitor who wants to asset strip & shut it down will pay less than an MBO team who have the 'once in a career' opportunity to run their own company)
  • a different view of risk, based on their own current situation and the other options they have

And therefore they will all offer a different price for that same business.

So how should you value your client's business? 

Don't even try!

About kirstymcgregor

About kirstymcgregor

Expert in corporate Finance for SMEs - which is a different subject to 'corporate finance' per se & we are the UK's experts in it!

Top 5 specialties:

  1. Assisting great general practice accountancy firms to grow their corporate finance service for SME clients:
  2. Revolutionary thinking - developing unique products and applications for SMEs
  3. Coaching accountants - technical updates, latest industry developments, new products/contacts in the market & peer group support
  4. Promoting accountants - developing a recognisable national brand
  5. Supporting accountants - providing access to resources & skills normally only in the domain of the large nationals

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By David2e
26th Oct 2010 22:29

Excel Template - Business Valuation System

We have a new Excel Template,

Business Valuation System

, which can certainly make it easier to get valuation figures together.

There's a free trial download there too so you can take a look first. We always welcome feedback too.

David Toohey
The Accountants Circle

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