Typically, at Beyond, we are focused on how entrepreneurs can grow their business, so it might be unexpected that we often end up discussing the principles of company valuation with our clients. However, the two subjects are intricately intertwined. That is because selling a company is not just a retirement plan, but it is a very attractive business strategy.
In Ireland, if you have a successfully growing company, it is not the best idea to take money out of it in the form of a salary or dividends because it is heavily taxed. Taxation for a company shareholder can be as high as 52%! That is why many entrepreneurs instead focus their efforts on building the value of their company so that they can sell it on. The sale can be tax-free if Retirement Relief applies or it can be taxed at as low as 10% if you are benefiting from Entrepreneur Relief, or in the worst-case scenario at 33%.
So how do you calculate the value of your company when the time comes to it? Let’s take a closer look at company valuation…
How to calculate the value of your business
What is important to remember is that there isn’t one company value. The value a company has is what a willing purchaser is prepared to pay for it. There are a number of techniques that will provide you with a range of values. Here are some of the main valuation methods:
Price-earnings ratio valuation
This is a common technique which determines the value of a company by taking a multiple of the profits. Let’s say the profits of a business is €100,000; then we might decide to value the business at 7x annual profits, so it would end up being valued at €700,000. There are many variations of this such as 1x annual turnover or 2x gross margin. Often the EBITDA is used as a marker, which is the earnings of the company before interest, taxes, depreciation, and amortization. In all cases, the value is based on the same thing – the earnings of the company.
Asset value valuation
What assets does your business have? Your assets will include property, the money people owe the company, cash reserves, etc. Generally, a growing company will not be valued by this method. However, a company that is not profitable or is in the process of closing down will be more reliant on its asset value. At Beyond, we had a situation recently with two partners who were 50/50 shareholders and one of them passed away. As would be expected, the deceased’s share of the business went to his estate. The existing shareholder wasn’t sure what to do. He was wondering whether to fold the company and set up a new company owned by him to continue the business, or whether to talk to the estate about buying the 50% shareholding. However, what came to light in our discussion was that a lot of the value of the business was tied up in the two main principals. Now with just one shareholder, the value of the company had significantly reduced. We took into account the value of their assets and liabilities, and although the overall picture was positive, it still did not amount to much. In this scenario, we decided an asset valuation was appropriate.
Know your industry
Different industries will have their own norms when it comes to valuations. Professional services often use a percentage of turnover as the go-to method of company valuation. For example, an accounting practice could go for 1x turnover or 1.2x turnover. Alternatively, a manufacturing company would more typically be valued at 8x net profit. Without a clear understanding of these industry expectations, you could easy undersell or overvalue your company.
Would you buy your company?
If you are trying to sell a company, ask yourself why you trying to sell it? More than likely the reason will be reflected in the price. If your company is always having problems, can’t seem to make money, is losing customers and burning you out, these problems will be reflected in the sales price. Essentially selling a business that is in this kind of condition is just passing a problem on to someone else. You would be lucky to get a buyer.
It makes sense that if the owners of the company are actively trying to sell the company, it will have a lower sale price than if the company isn’t for sale and a purchaser in the market is looking to buy it. This can result in a very high company valuation if you play your cards right, particularly if you can get more than one potential purchaser targeting your company at the same time.
The key takeaway is that if you want to make sure your company sells with a healthy valuation, then you need to ensure that your company is healthy as well. It is best if when you begin to think about selling the company, that you are in the position to also happily hang on to it. If this is not the case, then you need to take some time to prepare your company for going on sale.
Check out our blog on how to prepare to sell your company or give us a call and we can have a chat about your particular situation right now.