|The importance of setting the right price|
There are several commonly accepted methods of valuating a business to determine a selling price and obviously they do not all come to the same conclusion. As a seller you would want to get the best possible price but this would need to be reasonable in relation to what the business offers the buyer in terms of benefits. So you cannot simply look at all the valuation methods and choose the one that gives you the highest selling price. That could just set you on the path to an overpriced offering that will never sell. The longer the business remains unsold on the market, the lower your chances of a sale.
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|Separate the Property|
A buyer, for example, might be looking for a 33% return on a business (working on the multipler method of 3 years) - but it would be unrealistic to expect that the property component will realise that same return in investment.
|The true value to the buyer|
The point here is that even after you set a price, different buyers will assess the fairness of that price differently. What you need is to determine your price, be able to justify how you arrived at that price, and understand how much you can deviate (or discount) under conditions to secure a sale at a still acceptable price.
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|The different valuation methods used|
An ASSET Based Valuation is commonly used when the business is dormant or is no longer trading and/or not profitable. This could be caused by the the death of the owner or from a insolvency. Value is seen only in the equipment and stock assets. It can be as simple as the book value (assets less liabilities) or if in liquidation would be the liquidation value: if it sold the assets, settled taxes and debts and had a surplus left over.
See : The Value of Tangible Assets method.
An INCOME Estimate Valuation is used in service type businesses where there are very few assets and the business sells it's specialised labour and services. The value is in the potential that this business has to service client's and earn income month after month based on its reputation and returning customers. Current and future cashflows are analysed.
See : The Multiplier / Net Profit / Payback method.
The MARKET Approach Valuation is utilised mainly with small businesses where one examines the industry and notes the value of similar sized business in much the same market. Not too different to real estate.
See : The Industry Rule of Thumb method.
Price of Business = (Plant & equipment) plus (EBPITD for 1 Year) plus (Cost of Stock)
(EBPITD = Profit with add back of Proprietor's Drawings, Interest, Taxes, Depreciation)
|INDUSTRY RULE OF THUMB Method|
The variations between individual businesses and their market conditions may make reliance on a rule of thumb seem plain foolishness. But if the rule of thumb gives a result similar to the Multipler or ROI methods, then that can be used to support your pricing logic argument.
|ENTRY COST Method|
|VALUE OF TANGIBLE ASSETS Method|
|VALUE OF INTANGIBLE ASSETS Method|
|CAPITALISED EARNINGS / ROI Method|
(Adjusted Annual Profit) X (100 / Required Rate of Return) = Estimated Value
|MULTIPLIER, NET PROFIT MULTIPLES or PAYBACK Method|
Firstly, the annual income figure is adjusted in the same manner by adding back interest paid, tax, depreciation and the owner's drawings.
Risk is assessed by allocating a payback period which is determined by the risk of failure profile. So for a very risky business with no resellable assets, a buyer might want to recoup the purchase price paid within a year, but for a very low risk business with a good, value holding asset base a buyer might be happy with a four year payback. So if the business makes R600 000 per year, a high risk multiple 1,5 assessment would mean the price is R900 000. But a low risk multiple 4 assessment would give a price of R2,4 million (R600k x 4). In the capitalised earnings ROI method above, these would be 66% ROI and 25% ROI.
A business rich in assets lowers the risk profile, and simple supply and demand can also effect desirability which you can factor into the risk to a lesser extent. Restaurants, pubs and fast food outlets, for example, are often available in abundant supply.
The problem with this method is that the multiple should be based on risk, but it is often quoted as standard for an industry. Most similar looking businesses in the same industry could have very different risk profiles. In practice, the multiples can vary from x 2½ to x 6 or x 7.
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|So, what price method would one use ?|
BE READY TO JUSTIFY YOUR PRICE DETERMINATION
But remember that most buyers will always ask you how you arrived at your price. Being able to answer that in a confident and logical way will establish credibility and let the buyer move to the next stage of confirming value.
At the end of the day, a business is only worth what someone is prepared to pay for it
OFFERING A STRUCTURED PRICE
And don't forget that how you offer the transaction can also effect the price. This refers to negotiability. Insisting on a full cash deal up front may seriously limit your market, and you may need to offer an alternative lower price for a buyer who can provide a full cash payment. If you can structure a creative deal that allows for some element of self funding, then you should be able to request a higher price.
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