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Business Valuations: A Call to Action!

David Ohlmeyer • Mar 28, 2017

Imagine the following....

The time comes to sell up. You have an awesome business, sales have grown 20% per year for the past three years, the opportunities are endless and buyers should be climbing over each other to acquire you. Then you list with a well-regarded business broker and one by one, the suitors disappear. Any offers you receive are substantially lower than your asking price. In fact, they only cover your stock and equipment, and not the $1M of goodwill you thought was a given. You can't work it out. Okay, you know you are working around the clock to keep the place going, but that's why you've decided to let someone else have a go. Sure, your cash position is getting worse every week, but that's why you hoped one of your competitors with cash-laden pockets would step in and help you out of a hole.

So what's it all about?

People pay a price for value. When it comes to businesses, investors do their due diligence, because buying a business for millions of dollars is a big decision and no-one likes getting their fingers burnt. The bottom line? Investors will pay a price for a business, but only according to the value that they can extract.

This begs the question, how do you create and improve business value?

The first thing you need to understand is how business value is calculated.  There are many methods for valuing businesses, but the most common and widely accepted formula is the Capitalisation of Future Maintainable Earnings method (to use the technical name).  Put simply the formula is:

          Profits X Capitalisation Rate = Business Value

The reason that we look at profits is that the purchaser of a business wants to know what the predictable financial performance of a business is likely to be over the foreseeable future.  

The capitalisation rate is related to assessing the level of risk involved in the business being valued.  The lower the risk, the higher the capitalisation rate will be. 

So there are two factors at play here – profits, and risk.

You can focus on increasing your profits, as this will drive an increase in your business value. Likewise, you can also assess the risks attached to your business, and work to reduce or eliminate them, as reducing risk will also increase your business value.

We all know the profit piece fairly well. We can:

·        Increase sales

·        Increase gross profit

·        Decrease overheads

All things being equal, these three steps will deliver the profit increase we require. It's not rocket science!

However, reducing risk can be a longer term challenge.  Ultimately, investors like businesses that are boringly predictable.  There are many factors which reduce the risk associated with a business.  Some of the key ones are:

·        Low working capital requirement, quick cash conversion cycle (aka, cash 

         cow)

·        Strong supply chain; diversity of suppliers

·        Regular repeat sales (annuity type income)

·        Diversity of customers (by size, industry, geography, no reliance on a few 

         customers for the  majority of sales)

·        Well managed stock

·        Retention of staff, particularly management, following transfer of 

         ownership

·        Strong processes and information systems that allow the business to run 

         like a  well-oiled machine

·        Protection of Intellectual Property


The crunch line? I'd like to challenge you. Do you know what your business is really worth, and are you doing what you can to improve its value? Remember, working on the profits and capitalisation rate now, even if you're not planning on selling, will make your business more profitable (obviously), easier to manage, more cash positive, and less time consuming. What more could you want?

At KDA Group we're all about helping you to maximise your potential, and this includes business value.  If you think you might need some assistance, we're only a phone call away on 02 4861 8383.

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