By Des Chambers
Editor’s note: In our last issue we asked the question ‘What is my business worth?‘ This month we ask, ‘How do I calculate the worth of my business?’
This article is a brief guide for those SME and even SMME owners who are considering retiring, moving on or would like to sell their business for one or other reason. The focus is on owners of businesses valued at less than R20 million.
Generally, in valuing a business, historical financial information is used to determine the financial performance and in particular the profitability of the company. Sometimes, if the assets used by the business are worth considerably more than their book value, then depreciation may be added back to reflect this (BDIT). Examples would be fixed assets like property and land, and other valuable assets like antique furniture, proprietary software etc.
A price-to-earnings or P/E ratio is then established, taking into account many factors such as:
- Asset value
- Locality – where is the business situated?
- Lease period and rent
- Gross margins
- Brand (where applicable)
- Working capital needs
- Growth trends and current events that may affect the business.
Using the above, a guide price for the business can usually be arrived at by a business broker or accountant. The resultant return on investment (ROI) will determine the period it takes to recoup the purchase price, and this is a key factor for any prospective buyer. Based on current profits, how soon can they expect to get their money back?
Profits often vary due to cyclical factors, so sometimes an average of 2 or 3 years profits will be used.
In some sectors, the value of the business is determined more by turnover and gross margins. but invariably there is a counter check with the ROI.
Security of tenure is often of paramount importance in assessing value. Nobody wants to buy a business that only has a few months left on their lease, as this creates too much uncertainty.
Note that when presenting figures prior to a sale, the information on the business must be properly packaged in a suitably organised and documented manner. This ensures that potential buyers view your business in its most favorable light while providing concrete documentation for review.
Correct preparation is crucial and as mentioned above, a primary requisite will be the presentation of up-to-date financials.
In an ideal situation, pre-planning a sale should commence many months in advance, enabling the owner to ensure that full information is available and records are in order.
The guidance of an experienced business broker will assist with what can be quite a challenging process, not just logistically but emotionally as well.
Des Chambers is a qualified Chartered Secretary and Management Accountant and is registered as a Master Practitioner in Real Estate (MPRE) with the Estate Agency Affairs Board (EAAB). He has previously been employed with JSE listed companies in the manufacturing and property fields and is now the Principal and owner of Cape Business Bureau which was established in 1953 by the late Solly Joffe.