What is my Business Worth?

How Much Is My Business Worth?

This is the $64 million dollar question all business owners struggle with when contemplating a sale, and the reverse concern of buyers when purchasing a company. Unfortunately, there is not an easy answer, and, more confusing, there are probably several answers. This occurs because for most part, appraisals are an art, not a science and are subject to the appraiser’s judgment, skills and the availability of comparative completed sales.

Several methodologies exist for the valuation of SME businesses to achieve a Fair Market Value (FMV), although the most accepted methodology in New Zealand is the ‘Capitalisation of Future Maintainable Earnings’ (FME).

What is a Fair Market Value (FMV)

The FMV is the sale value at which a going concern business would change hands between a willing buyer and a willing seller, when the buyer is not under any compulsion to buy and the seller is not under any compulsion to sell, and where both parties have a reasonable knowledge of the relevant facts.

The majority of SME businesses in the New Zealand market will be appraised by a Business Broker or an accountant, using the ‘Capitalisation of Future Maintainable Earnings’ (FME) methodology or a similar valuation method. We assume that a SME is a business that offers a return on investment after an owner’s salary, and in most cases, has a management structure.

Capitalisation of FME in simple terms involves calculating the following:

  • The net surplus figure for your business, quoted in most cases either as EBIT (Earnings Before Interest and Tax), EBITDA (Earnings Before Interest, Tax, Depreciation or Amortisation) or SDE (Sellers Discretionary Earnings) with SDE being most often used for owner operator sized businesses.

  • This figure is often based on an average of the last three years’ performance of the business, and in some cases, only on the current year should the business be either growing or declining.

  • A multiple (or Capitialisation rate) is then set based on comparative sales and any positive or negative factors which could influence the businesses ability to earn that return going forward.

Example

A SME with little risk to its future maintainable income with contracts in place, long term employees, limited competition, excellent market acceptance and healthy cash flow could have a multiple of earnings of approximately 3 to 4 times its EBIT. On the other hand, a SME in the same industry which has increased risk to its FME, with cash flow difficulties, staff and lease issues and outdated products and services would more likely be in the 2 to 3 times EBIT range.

One of the characteristics of utilising the Capitalisation methodology is that an agreed upon value includes all of the tangible assets (stock + plant and equipment) required to run the business, but does not include the business’ working capital.

In simple terms, to achieve a Fair Market Value we identify the net surplus (EBIT, EBITDA or SDE) for your business and apply a multiple to those earnings which reflects the risk associated to a new owner being able to achieve those earnings in the future.

It is often said that a business is worth what a buyer is willing to pay, modern market conditions can dictate that a business is worth what a Bank, or an owner, is willing to finance.