What is your Business Worth?

What is your Business Worth?By Martin Richardson, Principal, WHK Gosling Chapman

You know the value of your house, your investment property, and even your car, but do you know the value of your business and what drives that value?

Insurance companies often talk about a person’s income earning capacity being their most valuable asset and income protection insurance is available to protect the loss of that earning capacity.

Similarly, a well performing business is likely to be one of the best investments, but do you know how much is tied up in your business and how you can unlock its potential? A look at a company’s balance sheet will not always tell the story of what the company is worth.

We experience a steady flow of valuation assignments for various reasons. Clients seldom appreciate the value of their business - some are pleasantly surprised and some have unrealistic expectations.

Valuing the Business or Shares?

The basis of any valuation is what a buyer and seller would be prepared to exchange in monetary terms to own the business or shares:

1. The value of shares in a company takes into account all of the assets and all of the liabilities and obligations of the company.

2. The value of a business only takes into account the assets that are being sold, and any liabilities that are being transferred (usually none).

Consequently, the value of a business can be quite different from the value of the shares in the company that operates the business.

Goodwill and Other Intangibles

Frequently a business’s value will exceed its existing tangible assets. When it does, the difference is the value to be attributed to intangible assets such as goodwill, and intellectual property of all kinds.

Valuation Approaches

1. Discounted Cashflow

In many cases, the value of your business is equal to its estimated future cashflows discounted to today’s value, at a rate which reflects the risk inherent in the business (“the discounted cashflow method”).

This involves an assessment of:

• Future cashflows (including growth)
• Risk

The use of future cashflows, discounted to today’s dollar, brings in one of the key valuation principles – the time value of money. Time value of money essentially says that $1 earned in 5 years will be worth less than a $1 today, due to inflation etc.

The discount rate or factor applied to cashflows reflects the risk of achieving those future cashflows, including risks inherent in the business - the greater the risk, the higher the discount rate applied.

2. Price Earnings Ratios

On stock exchange listings you may see references to PE’s (price earnings ratios). The PE ratio in essence reflects the share price of a company as a multiple of its earnings. Typically the earnings are stated as EBIT (earnings before interest and tax). For example, a company earning a $1M, with a PE ratio of 10 will have a value of $10M.

For private companies, earnings multiples are usually much less than public companies. This is because private companies are less readily saleable, typically smaller and often are more reliant on key individuals within the company.

Increasing the Value

There is strong demand for good businesses from both private investors and corporate investors looking to expand.

To improve the value of your business you have to:

1. Increase future cashflows and / or

2. Reduce the risk of achieving those future cashflows

To improve cashflows, businesses need to achieve greater sales, better margins and/or reduced costs. This could be as simple as asking your supplier for better terms.

To reduce the discount rate (that is lower risk), reliance on key personnel, key suppliers or key customers should be removed and better systems implemented and documented.

Obtaining a Valuation

Some industries have an established approach to determining sale prices, in which case business brokers experienced in the industry can assist. However, in most cases, valuations require a high degree of valuation experience, objectivity, judgement, and access to national and international market data for your industry.

WHK Gosling Chapman’s valuation assignments frequently arise from transactions that include transfers to a modified ownership structure, a transfer between existing owners, a dispute resolution process, or on the acquisition or sale of a business (or shares). However there are also clients, who either by reason of shareholder agreements or because they drive their business on a valuation basis, value their business on an annual basis.

By undertaking the valuation and understanding the value drivers, better business decisions can be made.

For further queries please contact your WHK Gosling Chapman on +64 9 303 4586.

The advice here is general and should be discussed with your accountant or lawyer who will put this into context around your business needs.