I am often asked to give a rough idea of the value of a business.
This is a fascinating question. However, it can only be answered by digging into the business details. In the real world, many variables are involved in business asset valuation. These include market sectors, individual ProfitProfit and risk levels, and industry types.
This is especially true for privately-owned small businesses, regardless of whether they are incorporated as private companies or sole traders.
Privately owned businesses in Australia are not required to file financial reports with any statutory bodies or publish details about their activities.
Publicly listed entities (companies listed on a stock exchange) provide more data for business valuation companies to analyze in the form of share prices, historical performance, and annual reports. These indicators can be compared to help determine a variety of valuation metrics.
Private businesses, however, are just as unique as fingerprints. Each company is amazing because it is ‘built’ around its Owner’s needs. Private companies require business analysis and valuation. This includes a thorough Risk Assessment, which considers the Owner’s Return on Investment and the Cost of Capital needed to purchase the business.
What to Consider When Value-Assuring a Business For Sale
Many SME (Small to Medium Enterprises) business asset valuations are focused on the “Return on Investment” (ROI). It is often expressed in percentages (%) and represents the Owner’s risk versus the Return. This should be between 20% to 50% for a privately owned business in Australia. The more secure the business investment, the higher the risk.
A business valuation report with an ROI below 20% would mean it is unlikely to bring in investment. Banks would not lend the funds for the purchase.
Private businesses and their valuations tend to be based primarily on historical financials. The valuation of intangible assets is based on adjusted net ProfitProfit (before taxes), known as EBIT (Earnings Before Income Tax).
Adjustments are made to the accountant-prepared financials to arrive at the actual Net ProfitProfit (before taxes).
The multiple of the Net ProfitProfit, temperated by the Risk profile and ROI percentage, will determine the Business’s Value.
While most people want a business valuation, they wish the PRICE.
Two very different numbers can be value and price.
What’s the Difference Between ‘Value and ‘Price?
If the purpose of the valuation of companies is to re-distribute shares for a Management buy-in, the price conclusion must be related to the market (is there a market for this kind of business?). So that even though the company is not being sold, a base price can still be established.
Similar to business valuations for divorce, where there may be an external transaction to buy, but sometimes one party wants to keep ownership and purchase the other. Both parties will want to know the “Fair Market Value” of the business to settle the matter even though it is not being sold.
Essentially, “Value” can only be based entirely on hypothetical theory. But “Price” in its truest sense can only be determined by what the market will pay.
Paul Nielsen graduated from Chicago’s Loyola University School of Business Administration and is a Certified Mergers and Acquisitions Advisor.
He is a Certified Practicing Broker (CPBB), Licensed Real estate Agent, Licensed Second Hand Dealer, and Accredited Sponsor of The Australian Small Scale Offerings Board.