By John Pitt
20-second summary
- ‘Removing risk’ is key to maximising the value of your business.
- Buyers want to think their investment is low risk.
- The owner’s knowledge is often a hidden asset that is lost in the sale.
- That’s why businesses with transferable systems and processes are worth more.
- To accurately value a business you need to truly understand what drives your profit.
Full story
Whether you are planning to sell or just want to improve the value of your business, the message remains the same—remove the risk.
As Sue Prestney, small- and medium-sized business spokesperson for the Institute of Chartered Accountants, says: “People are in love with their businesses, and they think that because they love it someone else is going to come along and fall in love with it as well, without really analysing what it is they are buying. That doesn’t usually happen in practice. A buyer is going to want to know that the return from their investment is as risk free as possible.”
Goodwill
Another potential stumbling block is goodwill. “The big problem with small businesses is it’s hard to distinguish the business from the current owner,” says Prestney. That makes it difficult to determine the value you’d attach to goodwill in the business once the owner is gone.
David Jackson, partner at HLB Mann Judd, chartered accountants, agrees. “Where a lot of small business owners go wrong is that often all the information about that business is inside their head. That fact can adversely affect the ultimate value of the business. People will generally pay a higher value when there is a system and a structure that can be duplicated.”
Prestney advises: “If, as the owner, you have the relationships with customers, then you need to start transferring them to other employees to make sure the business isn’t just you. All those things in your head—they need to be downloaded, documented and dispersed among other parts of the business.”
Valuation methods
There are several methods, but they all come down to what a potential purchaser is prepared to pay to derive the future income stream from your business.
To do the sums, says Prestney, it is essential to have a good analysis of what really drives profits. “That is the key to getting a proper valuation and working out what it is you have to fix to improve your value.”
The important calculation is determining what the future earnings stream will be on a maintainable basis and calculating the appropriate multiple. Future earnings are calculated on those that have been achieved in the past. However, a purchaser will take out anything that is abnormal or non-recurring. Having done this, the multiple can be determined based on the risk and potential in those earnings.
“By virtue of the valuation process, you have to go through all the key things that drive the profits and how at risk they are,” explains Prestney. “There could be intellectual property, for instance, or good systems, a good location or the current owner has a great relationship with customers and suppliers. Look at these kinds of things and consider how likely it is that they will disappear once the owner goes. The more the business is bound up with the current owner, then the higher the risk and the lower the multiple.”
Business potential
The other side of the equation is the potential of the business going forward. A potential purchaser will often pay a premium if they see a strategic advantage. For instance, a supplier might be interested in securing your customer list and distribution network. And often that strategic buyer is someone already known to the business owner.
“One of the big issues right now is to find that strategic purchaser by being on the front foot, targeting the people who are more likely to give you that strategic premium,” says Prestney.
Beware of tax
Tax liabilities can have a considerable impact on the amount you receive from the sale of a business. It is vital to speak to an accountant as early as possible in the process to determine whether or not you are eligible for small business Capital Gains Tax concessions.
Jackson suggests talking to your solicitor and accountant long before approaching a business broker to make sure all issues that might affect a potential sale are resolved in advance.
Terry and Alison Ray – Emerald Homestay, Central Highlands, QLD
For the better part of their lives, Alison and Terry Ray have enjoyed a family lifestyle in the Emerald District, Central Queensland. After running a boarding kennel and cattery on their property for 21 years, the couple decided to look at other business opportunities in the area. With industries as diverse as cattle, agriculture and tourism, they thought the Emerald district would be perfect for a traditional country style getaway.
So when their three sons moved out of home, Alison and Terry saw it as the ideal opportunity to transform their old Queenslander into an exclusive homestay. Not only is it a new direction for the couple, but also, the accommodation they have on offer is very different from anything in the area – Emerald Homestay is situated on around 13 acres of land, three acres of which have established gardens.
When the Rays decided to go ahead with Emerald Homestay in June 2006, they worked closely with their Westpac Relationship Manager to select the right solutions to help make their new venture a success. They started by installing an EFTPOS terminal in order to manage their cash flow, reconciliation, administration and customer service.
Also, through their Westpac Relationship Manager, Alison and Terry have secured a wheat farm loan, two business working accounts, two credit cards and a loan to build additional homestay units. These solutions have helped them to keep up with their goal of expanding on the current six bathrooms and eight bedrooms, with the addition of eight Italian-style units on the site.
The Rays strive to provide quality hospitality together with luxurious accommodation and the support of Westpac’s business solutions has provided them with a faster, easier and more reliable way of doing business.