How to Overcome a Crisis Event During a Business Sale – Video

If the financial performance of a business is temporarily impacted by a crisis event, unless the true underlying performance can be presented, the business sale may not achieve fair value until the crisis event has worked its way into history in the financial results.

In this video, we explain how to make extraordinary normalisation adjustments to help overcome a crisis event, while maintaining the integrity of the business presentation during the business sale.

If you found this video helpful, we’d appreciate a share or a thumbs up! Be sure to check out our complete ‘How to Sell a Business’ series for plenty of other tips and strategies for improving the outcome of your business sale process.

Adjusting Depreciation to Maximize Business Value

The lower the real depreciation, the higher the profit and the higher the value, maximizing your business value.

Actual depreciation is usually higher than the real depreciation applicable to business fixed assets. Replacing actual depreciation with a lower provision for capital replacement usually increases the true profit and therefore your business value.

In this video we explain how adjusting for real depreciation can lead to maximizing your business value.

Valuing $1M+ businesses (with free business valuation calculator) – Video

Everyone who sells their business wants to know how it’s valued. Here we explain valuing $1M+ businesses & include a free business valuation calculator.

Click here to download the Business Valuation Calculator: Download

A surprising number of business owners who have worked in their businesses and owned them for many years, even decades, don’t know how businesses are valued, let alone how much their business is worth and how to optimise their overall outcome in the sale.

In another video we explained how to value small businesses that are worth less than $1M.

In this video we explain the valuation principles most buyers use for $1M+ businesses and show examples of works in practice.

How to sell a business: Valuing a small business – Video

The majority of businesses are valued at less than $1M, here we explain valuing a small business…

The vast majority of businesses are worth less than $1M. Infact, 95% of all businesses are in this category, typically they employ fewer than 10 people and are affordable by most aspiring individual business owners.

The key to knowing how these businesses are valued lies in what those aspiring buyers see in the business. Usually they expect to work in the business and earn both the business profit and owner’s wages. We call this the buy a job market.

In another video we’ve suggested that the appropriate profit measure for these businesses is Net Profit before proprietors’ wages, which may be one or more working owners.

In this video we explain valuing a small business in this market.

How to sell a business: Selecting the right profit measure – Video

Business owners preparing to sell often discover profit measures for the first time, even though they are critical when selling a business.

There are several terms relating to profit measures, including Net Profit Before Tax, Net Profit After Tax, Net Profit to Proprietors, EBIT and EBITDA.

In this video we will explain what these terms mean and draw distinctions between the various forms of Profit used when valuing a business.

This completes the series, covering all the aspects of working capital you should need to know when selling your business.

How to sell a business: How to optimize working capital for sale – Video

We explain how to optimize working capital to maximize the outcome during a business sale.

This is Video 3 of a series of videos specifically on working capital in the context of a business sale transaction, the aim being to clear up any misconceptions and explain how optimizing working capital can benefit the exiting owner.

In the 2 previous videos of this series, we discussed what working capital is and why it matters, as well as how to account for it.

In this video we talk about the key working capital elements to see how they can be optimized for sale.

This completes the series, covering all the aspects of working capital you should need to know when selling your business.

How to sell a business: Accounting for Working Capital – Video

Here is an explanation of how and why you should be accounting for working capital during a sale process.

This is Video 2 of a series of 3 videos focusing on working capital in the context of a business sale transaction, the aim being to clear up any misconceptions and explain how optimizing working capital can benefit the exiting owner.

In Video 1 we explained what working capital is and why it matters when selling a business.

In this video we explain how and why you should be accounting for working capital during a sale process.

How to sell a business: What is working capital and why it matters – Video

Most business owners and even some advisers don’t understand how working capital impacts a business sale. So, what is working capital & why does it matter?

There is a lot of confusion about the treatment of working capital when selling a business.

Working capital features in business valuations, sale price allocation and sale adjustment calculations, to name just a few.

Most business owners and even some advisers don’t understand how working capital can impact on the goodwill of a business and how it is accounted for in the context of a business sale. The consequences of not knowing can be dramatic, with owners giving away substantial value without even realizing it.

The topic is too broad and too complex to cover in a single video, so we’ve broken it into a series of 3 videos so each aspect can be properly explained.

This is Video 1 of a series of 3 videos specifically on working capital in the context of a business sale transaction, the aim being to clear up any misconceptions and explain how optimizing working capital can benefit the existing owner.

Handling declining profits during a sale process – Video

It is surprisingly common for businesses to perform poorly during a sale process period.

What can you do if during the sale process the current year isn’t going so well?

In this video we’ll explain ways to help overcome this very inconvenient issue so you can continue with your sale process without having to abandon it until the next upturn.

Valuing a small business for sale purposes

Valuing a small business for sale purposes

The value of a business is determined by the expected future net cash flow it generates.

With large businesses, the timeframe over which the cash flow is measured is often 10 to 20 years. The time value of money is such that Discounted Cash Flow (DCF) methods become more relevant over the longer term.

With small and medium enterprises, the relevant time frame is usually shorter. Simple cash flow and payback periods are more useful, as outlined in the methods below.

 

1.  Valuation based on Capitalisation of Earnings Method

We use the Capitalisation of Future Maintainable Earnings method to arrive at a base market value of the business.

The level of expected future maintainable earnings should take into account a number of factors, including the consistency of past results, whether earnings are increasing or decreasing and possible threats to future results.

Adjustments are made for non-relevant events and also to remove finance, depreciation and unrelated costs.

Although future maintainable cash flow is taken before depreciation, allowance should be made for future capital replacements.

This method of valuing a small business is similar to the way commercial property is valued. A commercial property earning net rental income of $1M may be simply valued by applying a capital rate of, say 10% to produce a capital value of $10M.

With a small business, the principal is the same. The Net Profit before finance, depreciation and owners’ salary and benefits is often the starting point. From the Net Profit is deducted the equivalent salary of all working owners, as well as a provision for capital replacement, to arrive at Earnings Before Interest and Tax (EBIT).

This is the equivalent of the net rental return on a commercial property, as the profit in both cases is after taking into account all labour inputs.

With a small business, the required pre-tax capitalisation rate of return is usually higher than on real estate. Investing in a small business is inherently riskier than investing in bricks and mortar. Just ask the banks!

A benchmark return for general business is 25-30%. This rate may be lowered for businesses with lower perceived risk and raised for others.

A small business with an EBIT of $1M is worth about $3.3M at a capitalisation rate of 30%. i.e. someone may be willing to invest $3.3M to earn $1M pa. (Calculation: $1M / 30% return = $3.3M.

The base value of a business under this method includes net working capital:

Net working capital = Stock + Debtors – Creditors

 

Calculations comparing property and business valuations are set out in the following table:

Property
Business
Future MaintainableNet Profitper the Trading Accounts $1M $1.2M
Add  normalisation adjustments (if any)
Net Profitbefore finance costs, tax, depreciation & Owners’ costs $1.2M
Less allowance for Owners’ labour input $(100K)
EBITDA (Earnings before interest, tax, depreciation & amortis’n) $1M $1.1M
Less Provision for Capital Replacement $(100K)
EBIT $1.0M
Divided by Capitalisation Rate (ie required return on investment) 10% 30%
Estimated Base Market Value of the Business
$10M
$3.3M

 

2.  Valuation based on the Net Realisable Value of Physical Assets

Where physical assets in the business are substantial or where the profit is small, the value of the physical assets may exceed the value of the expected future cash flow stream.

Plant & Equipment employed in the business should be itemised and valued. Assuming that the values are realistic, then this, plus the value of inventory, can be taken as the base value of the business.

Base Value of the business

The base value of the business is the higher of the value under the Capitalisation of Earnings method and the Net Realisable Value of the physical assets.

Goodwill, if any, is simply the amount by which the value of the cash flow exceeds the value of the physical assets.

The value of a business to a purchaser may be less than the business owner believes is a fair value because the business owner does not build in the same risk factors as purchasers do for unknowns and lack of familiarity with the business. Similarly, purchasers may place “special” value on the business, often resulting from additional strategic benefit or synergies they can extract from the business given their current situation.

The market value of a business is usually within a range from the base value as calculated and a higher amount purchasers are prepared to pay.

 

Other attributes of the business

Other factors include age of the business, techological obsolescence and the quality and length of the lease on the premises if location is critical to the business.

The purchaser is focussing on past performance to determine price, but is focussing on expected future performance to determine value.

 

Business Systems Analysis

Business Systems Analysis is a method of evaluating those other issues. This model covers key strategic issues in a business as follows:

Product Design and Development

  • Product attributes
  • Quality
  • Time to market
  • Proprietary technology

 

Procurement

  • Access to sources
  • Costs
  • Outsourcing

 

Manufacturing

  • Costs
  • Cycle time
  • Quality

 

Marketing

  • Pricing
  • Advertising/Promotion
  • Packaging
  • Brands

 

Sales and Distribution

  • Sales effectiveness
  • Costs
  • Channels
  • Transportation

 

A more sophisticated method

A more sophisticated valuation method is useful for larger businesses. Continuing Value of the business is another method of estimating value based on the present value of expected future cash flow over a specified period.


References for further reading

VALUATION – Measuring and Managing the Value of Companies, Second Edition.Tom Copeland,Tim Koller,Jack Murrin, McKinsey & Company, Inc. ISBN0-471-08627-4
Business Valuations Digest Centre for Professional Development