Most SME owners who were planning on selling their business in early 2020 were forced to put their plans on ice when the pandemic hit.
Since then, while some businesses have struggled, others have flourished and may now be wondering if it’s time to capitalise on their success.
Selling a business in uncertain times comes with some challenges and it’s vital to get a realistic view on value as early as possible in any process. Most SME owners don’t like cost or complexity and are often put off valuing their business by the belief that valuation is costly and complex. The bottom line is that it doesn’t have to be and during uncertain times, it pays more than ever to keep things simple.
In pure financial terms, the value of any business is the present worth of its income streams. The most commonly used measure of income for SMEs is EBITDA (earnings before interest, tax, depreciation and amortisation). A company’s valuation is typically based on a multiple of its historic and/or future EBITDA. The reason for choosing EBITDA is that it is a reasonably reliable indicator of true income/cash flow generation.
Calculating EBITDA multiples
Once you have established your EBITDA, you then need to select the correct multiple of EBITDA for your business, which will give you a valuation. To do this you should review companies in your sector which trade on a public exchange and find out the range of EBITDA multiples at which they trade. Pomanda, the company information platform which I Chair, is another way to access this industry data quickly. Accountants and corporate finance specialists can advise further, but it’s worth getting a sense through your own research first. Once you have established a multiple range you can then apply this to your own business’s EBITDA to generate a valuation range for your company.
What you will typically find is that the multiple range is quite wide. So if for example, you have successfully researched the pink widget sector and established that your sector peers are trading at EBITDA multiples of 7-12x EBITDA, what should you do next? As a next step, it’s important to understand where in this valuation range your company sits and ideally how to get to the higher end. There are three key factors which will affect this:
The first key factor is the level of confidence you can provide in your EBITDA number. For historic numbers, you can help with this by being fully transparent about all your costs and provide clear justification for excluding any non-recurring expenses. In terms of your forecast EBITDA, the closer you are in your financial year to achieving this figure and the more on budget, then the greater credibility will be attached to your numbers. Be realistic in the context of how your business trades. If, for example, you are a retail operator and Christmas is a key part of your annual revenue generation, then any purchaser is going to want to see your numbers delivered over Christmas before attaching a high degree of confidence to your forecast EBITDA number.
The second key determinant of EBITDA is your growth rate. The faster an acquirer believes your company will grow, the higher the EBITDA multiple they will typically pay. So have a look at the growth rates of the companies you are comparing yourself with. If they are forecasting earnings growth of 10% per year and trading at EBITDA multiples of around 7x, and you are forecasting that you will grow at 15%, then you have a solid basis to argue that your EBITDA multiple should be higher.
The third determinant of EBITDA is your liquidity. In simple terms, if you are a publicly traded company and your shares can be easily bought and sold, then they are considered liquid. If, as is more likely for an SME, you are a private company, where there is no formal market for the company’s shares and probably restrictions in terms of who they can be sold to, then your shares are considered to be illiquid. In valuation terms an illiquidity discount is normally applied to the public market EBITDA multiple of around 20-30%. So if you find a company with a comparable growth rate which is trading at 10x EBITDA then you need to apply this multiple to achieve a realistic figure of say 7-8x EBITDA to your own business.
Calculating your Net Debt level
So having established that your pink widget company should be trading at a 7x multiple of its £2m EBITDA, you arrive at an Enterprise Value of your business of £14m. The final calculation you need to determine to arrive at the price an acquirer will pay for your shares or equity is the Net Debt level within the company. Net debt is broadly calculated as Short Term bank debt/finance leases plus Long Term bank debt/finance leases minus Cash and Cash equivalents. So if your Enterprise Value is £14m and your Net Debt is £1m, then your Equity Value will be £13m.
If you are lucky enough to be able to generate serious competition, then it is more than likely that an acquirer will be prepared to pay a premium to the value implied by your previous calculations. However, they are a good basis from which to start and there are many M&A processes which have failed due to a refusal to ground their valuation expectations on a sensible basis. Bidders can choose to bid up the price of your company if they perceive that it’s worth their while. But if you set the initial price too high, then you may scare them all off from the outset. Focus on keeping your process simple and your figures transparent and you will end up with a realistic view on valuation.
Read more:
How to value your SME business during uncertain times