Valuation of your company
02 Sep 2016
There are a couple of reasons why you would value a business. Either you want to sell, you are thinking of acquiring another business or you are valuing your business for reporting requirements. By valuing a business on a regular basis it can also assist the owner in thinking about strategic objectives for the business, eg marketing strategies to be implemented in order to grow the business.Once this exercise have been performed the valuation can be used for gearing purposes as well.
What is the real purpose of a valuation in a sale transaction?
The valuation that was performed on a business is only an indication of ranges where negotiation can take place. The seller and the purchaser will now need to settle on a price agreeable to both of them.
Valuations can be affected by many factors
The longer the specific business has been existence the more reliance can be placed on certain assumptions that are used in valuations, eg market risk. It can also assist the potential seller to back up their forecasts for growth, capex and overhead estimates. The smaller the business the more potential risks there would be. Smaller companies are more vulnerable to adverse market conditions as they do not necessarily have the back up capital to carry themselves through difficult periods. The price at which a business is eventually sold is also affected by timing, eg if the seller is immigrating and timing is of essence then the business could be sold for a lower value.
Valuation methods that are applied by valuers
- Net Asset values: Asset based companies are often valued based on the assets that they own. A property company, for example, owns a property portfolio and generates its income from the rental of these properties. Therefore it would be valued based on the worth of its property portfolio.
- Price Earnings Ratio: This is the most common method and the valuation is determined by multiplying after-tax profit by the number of years a buyer is prepared to pay for these profits. An example best illustrates this. A business has profit after tax of R1 million. The valuer considers 7 years appropriate for your business. The value is therefore R7 million.
o How do you determine the number of years? This is obtained from the Stock Exchange which is considered an active market. Currently the market trades on just below 22 years of earnings. For a specific company, this number is reduced for smaller entities as they are not as marketable as JSE shares and they carry much higher risk. In today’s market an SME with a good track record can expect to get between 3 to 6 years of after-tax profits.
o Are adjustments made to after-tax profit? Adjustments should be made for once-off events (e.g. the sale of a large asset) and any other items which prevent making the after-tax profit a true reflection of the business’ profit.
- There are other methods of valuation such as discounted cash flow or entry cost (for new businesses).
- Experience of the management to grow the business going forward.
- How good is the relationships with other stakeholders of the company?
- Is there effective corporate governance in place?
- What is the business competitive advantages, what sets it apart from its competitors?
All these factors would have an effect on price earnings ratio that needs to be applied. For example, if a potential buyer likes the governance structures within the business he would be comfortable to increase the purchase price. Similarly if he feels that the board does not have the right experience a lower offer could be received for the business.
It is important to note that sellers should plan the selling of their business a couple of years in advance as it is normally required that the current management will need to stay on between two and five years depending on the complexity of the business.
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