10 factors that affect the value of your business
Thinking of selling? Or just curious to know the value of your business in case you do decide to put it on the market at some point?
Many business owners are well-wide of the mark when placing a value on their prized asset. They overvalue it and under-prepare for their exit, believing in a huge potential for their business that buyers unfortunately don’t see.
Your business is only worth what someone is willing to pay for it!
Having an inflated price fixed in your head can seriously hold up your exit strategy. Awareness of the factors considered in determining business value will help you avoid nasty surprises when you do take the plunge.
Some factors are obvious; others not so. Some you have control over; and others you don’t.
Understanding what influences business value enables you to take informed actions to increase it in the coming months or years.
Below is a boiled-down guide to ten of the most important considerations…
1. Reasons for selling
Why are you selling the business? If you’re forced to sell (and this is known by the buyer), the value of the business naturally falls.
Selling due to owner illness is a good example where you are in a poor bargaining position when it comes to selling.
Try to give yourself as long as possible to negotiate before you sell; rapid, forced sales will ultimately be detrimental.
2. Size of business
With all other things being equal, smaller businesses are often viewed as higher risk than larger, more established companies.
The very fact that the business has more employees and generates higher revenues may be seen as a sign that it is strong. After all, it must have survived difficulties in the market in the past and possesses the people and processes that have created an environment for growth.
A larger business tends to indicate stability — and prospective buyers like to see this.
3. Longevity of the business
How many years has your business been operating?
While potential is a very important factor in determining value, so is a strong track record over many years.
If you can demonstrate years of strong performance, steady cash flow, and an established loyal customer base generating stable recurring revenues, you are ticking many potential buyer boxes.
Businesses that have been trading for a year or two are far higher risk, even if they are performing well. They may be simply riding the market or a particular trend.
4. The nature of your business’s assets
If you run a manufacturing business, your tangible assets are much greater than most office-based businesses and this is a factor in its value.
If everything else is equal, building ownership, hardware, machinery, and stock make a business much easier to value than one where intellectual property is the main asset.
In reality, the value of a business depends upon many other factors that office-based businesses may score well with (such as customer loyalty, IP, brand strength, etc.)… so this factor needs to be balanced against the others mentioned here.
For a simple ‘asset valuation’ of your business, add up the tangible assets, subtract the liabilities, and that’s it!
5. The key financials: EBIT
What are your business’s earnings before interest and tax (EBIT)?
Any prospective buyer will want to know this figure as the most common basis for calculating the value of a business.
It essentially puts a figure on your profit. This includes all the expenses in the business, except interest and income tax expenses.
Another way to put it is: the difference between operating revenues and operating expenses.
A multiple of EBIT is a common method of valuing a business. For example, a 3 times EBIT multiple for a business with an EBIT of $400,000 gives a $1.2M valuation. Or a 5 times multiple on an EBIT of $500,000 gives a valuation of $2.5M.
What is considered a ‘normal’ EBIT multiple to use for valuation purposes?
This will vary between industries and is affected not only by the factors listed in this article, but also by market sentiment. For example, in a ‘bull market’ when there are a lot of buyers, valuations are higher and a business could attract a buyer willing to pay a 10 times EBIT multiple. That same business within a different market environment, with a less bullish sentiment many only attract a 3 times EBIT multiple.
Clearly, timing matters.
6. Future performance & projected cash flows
While past performance can demonstrate financial stability (very important), it’s future performance potential that will get buyers’ eyes lighting up.
It’s important to be able to show growth potential. With this in mind, how well does your business attract new customers and boost cash flow?
Is it retaining customers effectively so that cash flow and revenue remain healthy — or are customers dropping off the back as quickly as new ones are loaded onto the front?
7. Your specific industry sector
Your industry sector is important for two main reasons.
Firstly, selling your business at a boom time for your industry will naturally be beneficial over selling it during a depressed time. If you’re in the mining sector and the industry takes a hit, the business value is likely to decrease. Similarly, a prolonged drought might affect the value of your business if you’re in the agricultural sector.
For more of an idea on your specific industry, speak with us or a business broker experienced in your industry sector. You will be able to access data about recently-sold businesses to get an idea of valuations in your sector.
Secondly, some industry sectors have industry-wide ‘rules’ that do not necessarily apply to other sectors. For instance, the number of outlets is usually key for a real estate agency business; and customer numbers are key for a mobile phone company.
8. Structure of the deal
The way the sale is structured may affect the price you sell for. Flexibility to fit in with the needs of the buyer may help you command a higher overall price.
There are different ways to structure a deal, affecting the amount of tax payable and the debt service: an ‘all cash’ sale will usually mean a lower value than seller financing.
Here are some basic guidelines:
Seller financing: businesses sold without any seller financing generally sell for 10% to 15% less.
Stock sale/Asset sale: selling stock means a single capital gains tax for you but the buyer may prefer an asset sale to reduce income tax.
Allocation of sales price: consulting expenses are tax-deductible to the buyer so they may value a business more with a high allocation to consulting; you, as the seller, may want to limit the allocation to consulting because you will pay the ordinary income tax rate on it.
9. The cost of access to capital in the market
When interest rates are high, investors borrow less. It’s the rule of the market.
This naturally has an effect on the value of your business as there are fewer potential buyers; and any interested parties may drive a harder bargain than when capital is cheaper and more available, as the perceived risk is higher.
10. Other ‘intangibles’ in the business
The value of any business will also depend on other more subjective, intangible factors. These may change with the perceptions of different buyers and may be harder to quantify:
- How crucial is the owner to the success of the business?
- Is it located favourably?
- Is the business highly dependent on a few customers?
- Are customer and supplier relationships strong and likely to last?
- Is the management team and staff strong — and likely to stay if the business is sold?
- Does the business have intellectual property of great value (trademarks etc.)?
- Are systems, processes, and procedures clearly defined and documented?
- What is the business’s reputation in the market?
- Is it favourably placed against competitors?
- How marketable is the business?
Focus on what you can control!
Now you have an idea of the main factors involved in valuing your business, what are the next steps?
Beyond being prepared and making sure that all your paperwork is in order (including cash flow statements, historical and projected profit and loss statements etc.) make sure you have an exit strategy planned.
This should be flexible enough that you are not in the position of HAVING to sell for less than you would like.
Focus on the factors that you can control rather than those you cannot. This will help you get your business into the best possible health for when the right opportunity comes along.
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One of the most powerful decisions you can make with your superannuation is whether to run your own self-managed super fund (SMSF) and whether to invest in property through it. Most people know it's possible to use super to buy property. Far fewer know how to do it well. The following seven tips are designed to help you make the right decisions. 1. You Can Borrow Money to Purchase Property in Superannuation. Don't have enough in your SMSF to buy an investment property outright? Since 2008, superannuation held in a self-managed super fund can be used to borrow money for property purchase. This is done through a 'limited recourse loan' using a Bare Trust as the Custodian entity. You can't borrow the total value of the property—typically it's up to 80% for residential properties and 60% for commercial properties, with the required deposit held in the SMSF as security. The SMSF then makes the loan repayments, with rental income received by the fund and property expenses paid by the fund. Importantly, if there is a default on the loan, your other assets in the SMSF are generally protected from standard debt recovery and bankruptcy proceedings. The lender only has recourse to the property itself. Upon completion of the loan repayment, ownership of the property transfers legally to the SMSF. 2. Follow These 8 Steps to Set Up Your SMSF Setting up an SMSF properly can be a complex process. It’s best to set up an SMSF with the assistance of a qualified superannuation advisor, like us! We can assist with both the initial setup and the ongoing management of your fund. There are eight core steps to SMSF set up: Select the appropriate structure and name Sign the trust deed that covers how your SMSF is set up and run (it can have up to four members) Establish a trust for the SMSF by investing assets into the fund Register your SMSF with the ATO Set up a separate bank account for your fund Submit your tax file number (and those of any other trustees) Obtain an electronic service address to receive employer contributions into your fund (if applicable) Roll over funds from your existing superannuation account into your SMSF 3. Keep a Liquidity Buffer If you're buying property through superannuation, make sure you plan to keep a liquidity buffer of cash and/or shares in your fund. Lenders will check for this before lending to you—it should be at least 10% of the value you intend to borrow. But beyond satisfying the bank, it's simply good risk management. Property is an illiquid asset. Having accessible funds in the SMSF means you're not caught short if repairs are needed, the property sits vacant, or an unexpected expense arises. Because superannuation is central to most Australians' retirement security, the government has carefully regulated what can and can't be done with it. They don't want people gambling their retirement away on poor investments or incorrectly using their superannuation fund. 4. Use the Rental Income to Repay Your Loan You cannot live in the property you purchase through your SMSF until after retirement. Most people purchase an investment property and use the rental income generated to repay the loan—which makes excellent financial sense. The key is selecting a property that rents easily and delivers a strong rental return. Your purchasing criteria may look a little different to buying a home you'd live in yourself. For example, proximity to public transport, local amenities, and average rental rates in the area matter more than personal preference. 5. Get It Right and Enjoy Significant Tax Efficiencies One of the most compelling reasons to invest in property through superannuation is the tax efficiency on offer. These benefits can significantly improve the long-term return of a property investment compared to holding it in your own name. Key tax benefits include: No capital gains tax or tax no yearly investment earnings if under super caps. Salary sacrifice advantages if you're sacrificing salary payments into super, loan repayments are effectively tax deductible. Capped tax on investment income—the maximum rate of tax on income after expenses is 15%. Any capital gains on investments held for 12 months or more, is taxed at 10%. Standard investors outside super can pay up to 47%. 6. Follow the Same Due Diligence Rules as Any Property Purchase Buying through superannuation doesn't mean relaxing your standards. If anything, the rules governing SMSFs mean you need to be more rigorous, not less. Property is likely one of the most significant financial decisions of your life. Research, not emotion, should drive your choices. The same rules apply whether you're buying in or out of super: Visit and compare multiple properties Know the values of similar properties in the same area Get all property checks performed by the right professionals Shop around for the right loan structure and lender Don't abandon good investor habits just because the structure is different. 7. Always Get Quality Professional Advice Nothing comes without risk—but the right advice significantly mitigates it. The key is understanding what you're getting yourself into: making informed decisions based on accurate data; keeping a diversified superannuation portfolio that doesn't place all your eggs in one basket; and not underestimating how complex buying property in superannuation can be. Sound Simple? It’s all in the details. If the above tips have made it sound straightforward, know that the detail is where the complexity lives. Getting professional advice from the start helps ensure you make the best possible decisions for your future. When selected according to rigorous property-purchasing criteria, property can be an excellent way to grow your superannuation and increase your chances of building a retirement fund that supports the lifestyle you want. Ready to Explore Property in Your SMSF? Whether you'd like to discuss whether an SMSF is right for you or need help setting one up, reach out to Ascent Accountants . If you want assistance managing the property within your fund, contact the Ascent Property Co team .
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