Valuing uncertainty

A key issue with business valuations is the level of certainty that can be placed on future earnings. The optimistic seller wants potential growth factored into the numbers, while the pessimistic buyer would like to exclude anything that customers are not contractually committed to. With this in mind one may wonder how any transactions occur at all. Fortunately not all sellers are optimistic and not all buyers are pessimistic; indeed when the sellers are pessimistic and the buyers are optimistic, both walk away happy with the deal.

However the majority of business sales involve people who basically want a fair deal – they might fear being ripped off, they might hope for a great deal, but they generally expect a fair deal.

The issue that makes both sides feel uncomfortable is determining what a genuinely fair deal is. The underlying problem is that what is being sold is the future of the business, not its past. As the future is uncertain, so is the value of the business.

To this end, a source of comfort becomes what other people have paid for similar businesses. This can be found at www.valuemybusiness.com.au and can also be obtained from advisers and brokers that specialise in specific industries.

What many business owners find difficult to understand is why the sale value and the book value of the business are not the same thing. The fact is that these have never been the same.

Historically the difference in value has been catered for by adding a figure for goodwill if the sale price is higher than the book value. Alternately, if the sale price is lower than the book value, then the asset values are adjusted down through write-offs.

The reason that the sale value and the book value are different is because the book value is based on the businesses past, while the sale value is based on the businesses future.

In today’s market, there is a strong move away from discussions of goodwill and asset prices to a focus on EBIT and EBIT multiples. A key reason for this is that the asset structure of most businesses has fundamentally changed from owning property, plant and equipment to leasing it.

As a result many businesses have ongoing liabilities that exceed their debtors and forward orders. This is not because a business is in bad shape, but rather a reflection of the timeframe for the lease commitment exceeds the timeframes for sales commitments.

So the key discussion point and negotiating point will be around the sale forecast.

Anyone in business today knows that the horizon of certainty on a sales forecast is shorter than it has ever been, so what value will you place on what is beyond the horizon?

Andrew Kent is a director of BizExchange, an independent marketplace for business for sale or seeking investment. BizExchange has a directory of independent advisers and business brokers and information on valuations.

For more Selling Your Business blogs, click here.