Having spent time getting the business ready for sale the business owner will wish to extract as much value from the business as possible. There are many ways of valuing a business with some valuations based on a multiple of recurring income or possibly on gross profit generation but most use a calculation based on recurring net profits. Often a calculation is made of the recurring net profits of the business say over a three year period and a multiple is placed to this average of say between three and ten times the average profit depending on a number of factors such as:-
- The position of the vendor in its chosen marketplace.
- The type of business being conducted with some industries achieving a higher multiple than others.
- What is happening in that particular marketplace i.e. is there consolidation or a particular appetite for acquisitions in the chosen marketplace.
- What is happening in the current economic climate.
- The appetite of the purchaser to buy that particular business. It is possible the purchaser might be trying to grow his own business fairly quickly or expand in a different marketplace and may be inclined to pay a premium to achieve his aim.
The resultant figure using the average profitability and the multiple is termed as the goodwill of the business and the business usually adds the value of shareholders funds in relation to the balance sheet and adjusted for any changes in the value of assets shown in that balance sheet and for any hidden liabilities that do not appear in the balance sheet such as contingent liabilities and potential staff redundancies etc.
Depending on the parties the definition of net profit that is used in the valuation may vary but usually it is net profit before corporation tax and after adding back any excessive management remuneration (this is the amount being paid to the existing owner over and above what was agreed will be paid to a similar management team in the open marketplace) as well as any one off or abnormal item that appears either as income or a cost in a two year average under review. Some valuation models also add back interest paid and depreciation which would give a higher average net profit that may affect the multiple being applied to the valuation.
It is evident however that whatever basis of valuation is used based on net profit, the higher and more consistent the profits are before sale the better the value.