The goal of any business owner and potential seller should be to maximise their value and to be able to sell the business on the best terms, in the shortest time and for the least amount of stress.
The three most common reasons for sale are retirement, ill health and divorce. The first can be planned but the latter two can strike quickly, in an untimely manner. This may force the business to be sold at less than maximum value and for the most amount of stress.
If the business owner understands the key indicators of value then they can manage their business to be always ready for sale at any given time. So, what drives value?
Basically, it’s the true earning ability of the business multiplied by an appropriate capitalisation rate (or return on investment percentage).
The true earning ability of the business is the adjusted maintainable net profit for the working owner (PEBIT) or after a management wage (EBIT).
PEBIT = Proprietors Earnings before Interest and Tax
EBIT = Earnings before Interest and Tax
The key components of value are:
Capitalisation rate or return on investment (ROI%) – this can vary from 1 to 7 times EBIT based on the following:
Adjusted net profit:
Buy a job / wage will not attract as good a rate as, say, a net profit of up to $1 million, which will also not be as attractive as a net of over $1 million to the major corporations.
Length of establishment, brand name, location, staff/management structure, growth of business and industry, patents, days and hours worked.
Plant and Equipment:
Value and working life/depreciation
Value and saleability
Working Capital Requirements:
Strong cash flow businesses are more attractive than those with high debtors over a long period of time.
Length of lease:
Security of tenure and the term of any loan are indelibly linked. Ideally a lease and option of 10 years plus should be sought. The greatest security of tenure is to own the freehold.
Business owners should be aware of the features of a quality business that will attract a premium sale price. The typical premium buyer wants to enjoy life as well as own a business. This buyer wants as much disposable income as possible and the time off work in which this money can be spent, enjoyed or invested for future retirement. The following features are ‘must haves’ to be a quality business.
- Full and growing financial records at least 3 years.
- Net at least $100,000 pa EBIT after fair owners or managers wage.
- Allow owner operator to work only 5 days per week or less.
- Continuing and reliable staff in place.
- A minimum 7-year lease (ideally 10 years) at an acceptable industry rental.
- Sales income not dependent on the personal relationships or skills of the owner.
Other features that will enhance the value are:
- A well-developed strategic business plan.
- Written management and operations manuals.
- Protected patents, designs and intellectual property.
- Plant and equipment in good condition.
- Good and saleable stock at efficient levels.
- Suitably located and well-maintained premises.
- A niche market or high barrier to entry.
- Well-diversified customer base.
- Genuine reason for sale.
- Other synergetic businesses close by.
- Full transition assistance from the seller.
Business owners who take cash out from their businesses think they are smart but in reality if they have to sell quickly they can lose hundreds of thousands of dollars and end up far poorer in the long run. Any business that loses cash, whether to the owner’s back pocket or stolen by staff will be affected at time of sale. For example:
$1000 per week lost = $52,000 pa
Tax saving at 30% = $15,600 pa
@ 2 x $52,000 = $104,000 pa
@ 3 x $52,000 = $156,000 pa
@ 4 x $52,000 = $208,000 pa
For every dollar per week that disappears, the value of the business can be reduced by up to $200.
Who’s smart now!
If a buyer acquires a potential ‘cash reduced’ business, he will be able to create an attractive capital gain after 12 months.
Finally we should expand on a few tips to the seller.
One of the purchaser’s greatest fears is that the goodwill of the business will disappear when the owner leaves. To minimise this fear the business owner must give more responsibility to the staff in all departments. The more the business operates without you the better.
Business owners should also strengthen their industry networks and supply agreements. They should maintain strategic relationships, develop partnerships and have written agreements in place. A strategic supplier may become the best buyer.
In summary, to achieve the best price on the best terms in the shortest and least stressful time, the business owner should understand the key indicators of value, make the business operate without the owner and have a long term lease at a fair rent or alternatively own the freehold premises.