The valuation of a business––the true worth of your business––is affected by a number of factors which can either increase or reduce the benchmark value as provided by the ValueMyBusiness-RMIT Index of business multiples.
The Index is an earnings multiple is calculated for businesses across 19 industry classifications. However, the factors below impact on value in a positive or negative manner.
The factors that can affect value are:
While a dollar is a dollar, when it comes to assessing a business, different income sources have different values. What potential owners are looking for is some assurance that this year’s income can be repeated or improved into the future. Some professional private business investors refer to two distinct types of income generation activities as hunting and farming.
Profit margins are an indication of the level of demand for a service, as well as the strength of the competition a business faces.
The value of a business is greatly enhanced when the barriers to entry are high or the business has a competitive advantage.
Capital intensive industries, for example, such as the mining of iron-ore or the manufacturing of commercial airliners, are two industries where the costs of entry are so high that few choose to enter.
A competitive advantage for a business lies in:
The general rule is if a business has a competitive advantage, it is worth far greater than one that does not.
Getting into an industry early in its lifecycle provides a business with the potential to capitalize on a rapidly expanding market. It also runs the risk of the unknown, and the possibility that the potential market has been massively overstated.
At the other end of the lifecycle, businesses in declining industries may have limited opportunities for growth, although the lessening of competition may, paradoxically, stave off the inevitable demise and result in stable income, which may be attractive to certain owners and investors.
In between there are mature and consolidating industries in which the big tend to get bigger, and a key question for business owners is whether to grow (often through acquisition) or get out (often through trade sale).
Each lifecycle stage will be regarded as having more or less value to different investors. As such it represents a factor that affects the earnings multiples applied to a particular business in particular industries, as perceived by the potential owner or investor.
Many SME businesses are reliant on the owner operator. This can affect the value by the extent to which the business relies on the owner to operate:
If, for example, the business is reliant on the owner’s personal relationships forged over many years, a new owner may find it difficult to step into the role and run the business and justify the high asking price. The inevitable consequence:
Ultimately they have an adverse effect on profit.
As such the value of a business will be highly subjective, and the departing owner operator is in a difficult position. The business owner needs to show that she has a well-run business with a good reputation while at the same time present the business as having the potential to be run better and go further with the new owner.
Where there is a high level of owner reliance, the best strategy would be to prepare the business well in advance of selling it, so that owner reliance is minimised by:
As a general rule of thumb, the less a business is reliant on the owner operator the higher the value of the earnings multiple.
The market of buying and selling of businesses fluctuates over time. Some businesses are hot while others are to be avoided. For example, changes in legislation can encourage or discourage investment in particular industries. On the other hand, changes in society or demographics will also impact on the demand for particular businesses.
Australia is moving into a major demographic change, particularly among business owners, with the baby-boomers moving into retirement. The volume of businesses coming onto the market is forecast to grow significantly affecting the supply-demand equation, and thereby affecting price.